Bond Watch: why February ended on a high for bonds

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.        

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.        

• Invest with ii: How Bonds & Gilts work | Tax Rules for Bonds & Gilts | Open a SIPP

Here’s what you need to know this week.  

Falling US inflation welcomed by markets 

A measure for US inflation for January came in at just 2.4%, which boosted bond prices.  

The PCE inflation figures – or core personal consumption index – which strips out volatile items such as food and energy prices was at its lowest level since February 2021. The US central bank considers it a better measure of inflation than the headline consumer price index as it is less influenced by commodity prices.  

The fall from 2.6% in December suggests that expectations that interest rates will be cut around the middle of the year will hold true.  

• ISA tips: 10 things to know before investing in bonds and bond funds
• Shares vs bonds: which offers the best opportunity for income seekers?

US bond yields fell – a result of rising prices – in the wake of the news. The US 10-year government bond yield dropped from 4.35% to 4.25%. However, UK bond yields were unchanged.  

Nevertheless, Deutsche Bank strategist Jim Reid said the figure showed that inflation was still running above target.  

“So for now the market is relaxed, but inflation is proving a little sticky as we start the year. Perhaps the sanguine response is based on the fact that pretty much nobody now expects a March interest rate cut and a lot of water can flow under the bridge before June when the market expects the first one. So, plenty of time for a change of mind on things or for the data to change.” 

How did bonds perform in February? 

Bonds registered negative returns in February, as investors pushed out their forecasts for when central banks would cut interest rates. 

According to Deutsche Bank, US Treasuries dropped 1.4%, European government bonds dropped 1.2% and gilts fell 1.3%. 

On a total return basis, sterling corporate bond funds fell on average 0.5%, with income from coupons counterbalancing falling bond prices.  

• Bonds expected to be the best-performing investment in 2024
• The highest-yielding money market funds to park your cash in

Reflecting the fall in bond prices, the 10-year UK gilt, considered a benchmark for UK government borrowing costs, rose from 3.75% to 4.2%. 

Bond yields rise when prices fall, as investors are paying less for a fixed income, meaning that their future return is greater.  

Year to date, gilt funds have dropped 4% on average and sterling corporate bond funds are down just under 2%.