The end of 'set and forget' for government bonds

Why this matters for charities

Government bonds can play an important role in charity portfolios by providing income, liquidity and diversification. These characteristics may help charities meet spending needs while maintaining a balanced investment approach. However, when bond markets become more volatile, the length of time until a bond matures can have a significant effect on how much its value rises or falls.

This article explains the factors affecting government bonds and how we are currently managing these risks within the Rathbones Charity Growth & Income Fund. No action is required from readers, although trustees may find the article helpful when reviewing their charity’s investment risks and liquidity needs.

 

In brief

•    Bond yields have risen, which has caused the prices of existing bonds to fall.
•    We continue to see a role for government bonds within a diversified portfolio.
•    The Fund is holding shorter-duration bonds to reduce its sensitivity to further rises in yields.
•    Shorter duration can reduce interest-rate risk, but it does not remove the possibility of investment losses.

The value of investments and the income from them may go down as well as up and you may not get back what you originally invested.

The commentary reflects the general views of the investment manager and should not be taken as a recommendation or advice as to how any specific market is likely to perform. This information should not be taken as financial advice or a recommendation.

Information correct as at 18th August 2026.

 

The end of “set and forget” for government bonds

A sharp rise in bond yields, which means a fall in the prices of existing bonds, has left some investors concerned.
Several countries have passed significant milestones in their total levels of debt. Risks have also increased because of conflict in the Persian Gulf and its knock-on effects on energy costs around the world.

At the same time, a change of leadership at the world’s most important central bank, the US Federal Reserve, or Fed, took place during the typically quieter summer months, when market trading can be lower. Together, these factors have contributed to greater uncertainty in government bond markets.
This does not necessarily mean that investors should move out of bonds entirely. In our view, current yields offer more attractive opportunities than they have for several years.

For our Fund, this means being more selective and actively managing the risks within the fixed-income allocation. Fixed income refers to bonds and similar investments that usually pay an agreed level of income.

It may be helpful to start with the three main risks associated with government bonds:

• Interest-rate risk: If the interest rate available on a newly issued bond is higher than the rate paid by an existing bond, the existing bond will usually become less valuable. This is because investors can obtain a higher level of income elsewhere.
• Inflation risk: Higher-than-expected inflation reduces the spending power, or inflation-adjusted value, of the fixed interest and repayment amount that an investor expects to receive.
• Default risk: A government may be unable to meet its repayment obligations, potentially resulting in losses for investors. While default has historically been rare among developed economies, its likelihood varies between issuers and over time.

A government that needs to borrow more will normally issue more bonds. If the supply of bonds grows faster than investor demand, and other factors remain unchanged, bond prices may fall and yields may rise.

A bond’s yield is the level of income available from the bond relative to its current market price. When a bond’s price falls, its yield generally rises. When its price rises, its yield generally falls.

 

Summer can be a quieter time for major changes

Inflation and interest rates are closely linked. If inflation rises, central banks may increase interest rates to help keep price rises under control.
Inflation also reduces the spending power, or real value, of the income paid by a bond. Investors therefore take expected inflation into account when deciding what yield they require before buying.

The continued conflict in the Persian Gulf and a change in communication style at the US Federal Reserve are among the factors that have contributed to a difficult period for global bonds.

As the conflict involving Iran has continued, higher energy costs have contributed to renewed inflationary pressure. Meanwhile, new US Federal Reserve Chair Kevin Warsh’s less frequent communication style has increased uncertainty among some bond investors.
Some investors have sold longer-dated US bonds because of concerns that the Fed could be too slow to raise interest rates, potentially requiring rates to remain higher for longer in future.

In our view, investors may be placing too much weight on this short-term uncertainty. We believe it is sensible to assess developments over a longer period before drawing firm conclusions about the Fed’s approach.

We also think the effects of higher energy prices may be less pronounced than some investors expect. Developed economies are generally less sensitive to petrol and energy prices than they were in the past.

Higher petrol and energy prices can also act like a tax on consumers and businesses. As costs rise, people and companies may reduce their spending, which can ease some inflationary pressure.

For charities, higher inflation may also increase operating and grant-making costs, making the inflation protection and liquidity provided by the overall portfolio particularly important.

Central banks also generally try to look beyond short-term changes in global food and energy prices because monetary policy cannot directly control those prices.

 

Governments have work to do, but this is not necessarily a crisis

Default receives considerable attention, but a more immediate concern may be whether the growing supply of government bonds exceeds investor demand.
Fiscal deficits have been rising across major economies for several years. A fiscal deficit occurs when a government spends more than it receives through taxes and other income.

Until recently, bond markets challenged this trend only occasionally. We think this may be starting to change.

Governments have faced the successive costs of pandemic support, geopolitical instability, investment in energy and infrastructure, ageing populations and higher defence requirements. As a result, public finances are under greater pressure.

Why does this matter for bond investors? Higher borrowing needs can increase the supply of bonds, which may put downward pressure on prices unless demand rises at the same pace.

US government debt has surpassed $40 trillion, approximately double its level in January 2017. These figures are large in absolute terms. However, the US economy has also grown over that period.

Debt-to-GDP compares government debt with the annual size of the economy. On this measure, US government debt has risen from just over 100% of GDP to approximately 125%.

This is a material increase, but in our view, it does not in itself indicate an immediate sovereign funding crisis. Rising borrowing requirements and borrowing costs nevertheless warrant close monitoring.

The US is not alone. Many other developed economies face similar pressures as they meet the costs of pandemic support, ageing populations and more expensive public services.

The UK is estimated to owe just under £3 trillion in government bonds, up from approximately £1.7 trillion at the beginning of 2017.

The UK economy has also expanded over that period, reducing the relative impact of the increase. However, government debt has still risen from approximately 80% to 95% of GDP.

Governments face ongoing pressure to ensure that public finances remain sustainable over the longer term. Concerns about fiscal policy and increased bond issuance may cause investors to demand higher yields, reducing the value of existing government debt, particularly longer-dated bonds.

Higher yields also increase the cost of government borrowing, potentially adding further pressure to public finances.

Our bigger concern is therefore not necessarily government default. It is whether the growing supply of bonds can attract enough buyers without governments having to offer materially higher yields.

If investor confidence weakens, the higher yields required before lending to governments could reduce the value of existing government debt, particularly bonds with many years remaining before they mature.

Government debt has risen significantly in both the UK and US over recent decades.

While the headline amounts are large, growth in the size of both economies has partly offset the increase when debt is measured relative to GDP. Nevertheless, larger borrowing requirements may lead to more bond issuance and contribute to greater volatility in government bond markets.

Chart: Worrying, not catastrophic: UK and US government debt have both roughly doubled over the past decade, yet their economies have expanded too, making the burden less onerous

 

The bond vigilantes ride again

“Bond vigilantes” is an informal term for investors who sell government bonds, or demand higher yields, when they become concerned about inflation, borrowing or fiscal policy.

In our view, higher borrowing costs could ultimately encourage governments to strengthen their fiscal positions.

As bond investors become more selective about the governments they lend to and the yields they require, higher borrowing costs could increase pressure on governments to address the gap between public spending and revenue.

However, this process could also lead to greater volatility in government bond markets.

Government bonds, particularly UK government bonds known as gilts, can provide defensive support within a diversified portfolio. However, they can still fall in value, and longer-dated bonds are usually more sensitive to changes in interest rates.

This sensitivity is often described as duration. Duration measures how much a bond’s price is likely to change when interest rates move. In general, a bond with a longer duration will experience a larger price movement than a bond with a shorter duration when yields change.

Because gilts provide defensive support within our portfolio, we think carefully about how much interest-rate risk we take through these holdings.

That is one reason why our bond portfolio currently has a shorter duration than has often been the case historically.

We reduced duration further in early April, selling some of our longest-dated gilts as yields remained elevated and the outlook for government finances became more uncertain.

This does not mean that we will never invest in longer-dated bonds. We may still find individual opportunities where we believe the potential return adequately reflects the risk.

Overall, however, we are deliberately taking less interest-rate risk than we have at other points in the past.

 

What we are doing

• Maintaining exposure to selected government bonds.
• Holding fewer bonds with very long periods remaining before repayment.
• Focusing on income while retaining flexibility.
• Reducing, rather than eliminating, the Fund’s sensitivity to changes in longer-term interest rates.

In our view, current yields provide a higher level of income than was available across much of the recent past.
We believe this income can currently be accessed without requiring excessive exposure to longer-dated bonds, which are generally more sensitive to changes in interest rates and concerns about government finances.

By maintaining a shorter duration, we aim to capture some of the available income while reducing, but not eliminating, the Fund’s exposure to further bond-market volatility. The Fund may still fall in value, including during periods when government bonds would normally be expected to provide defensive support.

 

What this means for charities

Government bonds can continue to play a role in charity portfolios through their potential to provide income, liquidity and diversification. However, trustees should be aware that government bonds are not risk-free and their prices can fall.
Higher market volatility means that factors such as duration and sensitivity to interest rates may be particularly important when considering the risks within a bond allocation.

The Fund’s current positioning reflects our view that a shorter-duration approach may help manage some of these risks while retaining exposure to the income available from selected bonds.

Investors in the Fund buy units in a diversified, multi-asset fund. They do not directly own the individual government bonds discussed in this article.

The appropriate approach will depend on each charity’s objectives, time horizon, spending plans and ability to accept investment risk. Charities should consider seeking advice from an appropriately authorised adviser before making an investment decision.

The value of investments and the income from them may go down as well as up and you may not get back what you originally invested.

For more information about the Fund, including its objectives, risks and charges, please click here.