Moreover, the UK government has increased spending in response to Covid, following the trend set by its global peers.
This has led to a rise in bond supply, exerting some upward pressure on longer maturity bonds.
Government bonds, especially short maturity tenors, offer good value. Although short-term challenges may arise from stronger US growth and inflation, we foresee 2024 as the year of global divergence, with the BoE likely to cut interest rates.
Currently, five-year UK government bonds yields are yielding 4.2 per cent, almost 1 per cent higher than the UK consumer price index.
Likewise, for savers seeking protection against future price rises in the UK, inflation-linked bonds are currently offering a positive real yield, meaning you can lock in a savings rate above the inflation rate.
In the credit market, investment-grade corporate bonds offer good value.
Investment-grade corporate bonds have historically performed well in the 12 months following a central bank pause, as investors allocate to credit with attractive yields. Currently, investment-grade corporate bond yields are 2 per cent higher than the dividend yield on the FTSE 100.
Our favourite segment within the credit market is short-dated corporate bonds with one to five-year maturities.
These investments work in various scenarios and offer attractive returns. If government bond yields remain relatively unchanged, investors can benefit from an additional 120bps of yield. If yields fall, the asset class will produce strong returns.
If growth weakens and spreads rise, the decline in government bond yields should offset most, if not all, capital losses, ultimately leading to positive returns when factoring in the starting yield.
However, we are more cautious about high-yield debt, as its compensation relative to investment-grade corporate and government bonds is insufficient. For example, the yield on US high-yield corporate bonds relative to cash is currently at its lowest this century.
This certainly warrants some caution in higher risk segments of fixed income.
In conclusion, the UK bond market is entering a new era, with compelling opportunities for investors seeking income and capital gains over the medium to long term.
Thomas Maxwell is an investment director at Abrdn.
