Investors in government bonds could do well out of a recession, investment analysts have claimed.
Last week, official figures showed that the UK’s economy had shrunk by a larger-than-expected 0.3 per cent between October and December.
As it had already shrunk between July and September, it means that the UK technically fell into a recession at the end of last year.
Some economists have predicted that the US is also likely to be hit by a recession in 2024, although most analysts expect any recession to be mild on both sides of the pond.
Generally, a recession can spook investors. While this might not be good for your stocks and shares, it may be good for those with money in bonds.
“There are four interest rate cuts now priced for the Federal Reserve (the US central bank) in 2024, and a notable recession would likely see more cuts than this delivered,” said CJ Cowan, portfolio manager at Quilter Investors.
“Consequently we would expect government bonds to perform well in this sort of environment.”
Rate cuts ahead?
If the central banks are concerned about the economy shrinking or growing too slowly, they may cut interest rates as a way to increase consumer spending.
Hal Cook, a senior investment analyst from Hargreaves Lansdown, said: “If the Bank of England believed this to be the beginning of a deep recession, then their response should be to cut interest rates.”
If this happened, he suggested it would be good for government bond values, as yields would be expected to fall, and bond prices move in the opposite direction to yields.
A recession would in theory be positive for the government bond market, but much will depend on how inflation and the labour market are behaving.
There is also what is known as the “safe haven trade”, which can help bond prices rise when stock prices fall.
When stock markets are in trouble and going through a negative shock, investors can get spooked and sell equities, often moving their money into what is considered a “safe” investment — like government bonds.
Cook added: “If the recession does turn out to be a bad one, that’ll likely mean large interest rate cuts by the Bank of England which would be very positive for bond values.”
Stagflation
But Cowan, who said that he did not expect a “deep” recession, also warned that bonds could be affected negatively by the risk of stagflation.
Cowan said there was no strict definition of stagflation, but it generally refers to when slowing or negative growth and high unemployment coincides with rising inflation.
In this scenario, central banks may struggle to cut interest rates to kickstart the economy if inflation is not falling as expected.
“The longer interest rates remain at current levels, the more pressure is put on indebted households, companies and (particularly now) governments, thereby raising the chances of a recession,” said Cowan.
“This stagflationary scenario of high inflation and low growth would not be good for nominal government bonds, although inflation linked bonds could perform well.”
Laith Khalaf, head of investment analysis at AJ Bell, agreed. He said: “A recession would in theory be positive for the government bond market, but much will depend on how inflation and the labour market are behaving.
“Recessionary conditions should pour cold water on domestic inflationary conditions, but as we know the UK’s inflation picture is susceptible to exogenous shocks, especially around energy prices.
“Sticky or fresh inflation could prompt the central bank to keep interest rates high even in the face of recession, which would be negative for the gilt market.”
Imogen Tew is a freelance financial journalist