In recent weeks, the average yield on global government bonds in the Bloomberg World Government Bond Index has surpassed 4%, reaching its highest level since 2000. From a valuation perspective, investors may consider allocating more funds to fixed-income assets.
This reasoning seems even stronger, as the earnings yield of S&P 500 stocks—the inverse of the price-to-earnings ratio—relative to sovereign bonds has fallen to its lowest level in over 20 years. In other words, the earnings yield advantage offered by US stocks compared to government bonds has narrowed significantly.
Shorter-term government bonds appear particularly cheap. We believe that the current yields on these bonds reflect market expectations that the Federal Reserve will raise interest rates more times in the future than it will actually do. This is because we expect inflationary pressures to eventually ease.
Even so, we do not agree with the view that government bond allocations should be overweighted at this time.
Even if we believe that the Fed's future rate hikes will not be as aggressive as the market currently expects, there are still other risks besides inflation that could continue to cause volatility in the government bond market.
First, the public sector fiscal deficit remains high, continuing to exert upward pressure on government financing costs. Meanwhile, economic growth in the US and other parts of the world continues to exceed market expectations.
Furthermore, the Federal Reserve's interest rate decision-making framework may change. New Fed Chairman Kevin Warsh has pledged to review the Fed's policy framework, including how the institution measures inflation and how to prevent inflation from overshooting again. Any change in policy stance could trigger another significant rise in bond yields.
For these reasons, we prefer to maintain a neutral allocation to developed market government bonds.
(The above views are from Pictet Asset Management on October 5th and are for reference only, not investment advice.)
