Bonds have their mojo back

Higher starting yields have restored the return potential of government bonds despite continued uncertainty about rates and inflation.

• A 10-year US Treasury yielding 1.51% at the start of 2022 fell to a 5.29% yield by 30 September 2026, producing a total return of -13%, or -2.9% annualised, assuming constant maturity.
• If the same 3.78 percentage-point yield sell-off were repeated over the next 4¾ years, yields would reach 9.06% by 30 June 2031, yet the bond would deliver a hypothetical 9.3% total return, or 1.9% annualised.
• The 22.3 percentage-point difference between the two return outcomes equates to roughly 4.69% per year, reflecting the higher starting income and some convexity benefit as duration falls at higher yields.
• A separate three-year example shows that a 1.51% starting yield on 31 December 2021 combined with a 3.06 percentage-point yield rise led to a -14.6% return, illustrating the downside of starting from very low yields.
• The outlook remains dependent on geopolitical supply shocks, hyperscaler and AI-related capital expenditure, and fiscal discipline, all of which the author identifies as unresolved variables.

Takeaway: With bond starting yields now at multi-decade highs, income provides a stronger cushion and the prospective returns look more attractive, although the conclusion does not depend on a forecast for geopolitics, inflation or fiscal policy.