Sovereign bonds revisited

Sovereign bonds from developed markets have long played a diversifying role in multi-asset portfolios, offering a degree of protection during periods of uncertainty, high returns during their golden age (1990-2010) marked by falling global interest rates, and portfolio stabilization thanks to their negative correlation with equities. Today, investors are less confident in these virtues. We analyze how to rethink sovereign bonds within multi-asset portfolios and capitalize on investment opportunities as they arise.

The negative correlation between stocks and bonds, prevalent before 2022, has become less reliable. Even gold, often touted as an uncorrelated asset, has tended to exhibit a positive correlation with stocks. Over the past two decades, the fundamentals of developed market sovereign bonds, particularly budget deficits and public debt levels, have deteriorated somewhat. Moreover, the ongoing geopolitical transition continues to reshape global demand for sovereign bonds.

The negative correlation between stocks and bonds, which was predominant before 2022, has become less reliable.

No sovereign debt crisis in sight

Recently, political risks have contributed to rising sovereign bond yields in France and are now leading to significant increases in Japan. However, despite the deterioration in fundamentals, investors should not fear default or a sovereign debt crisis. Such crises do not arise from exceeding a budget deficit or debt-to-GDP ratio threshold. They occur when governments can no longer finance their debt domestically. This capacity depends on the proportion of public debt held domestically relative to that held abroad, as well as the country’s net external position. Current account balances play a major role in this latter aspect and have improved in many economies over the past fifteen years.

For highly indebted countries, a current account deficit exceeding 5-6% of GDP generally marks the threshold beyond which debt-related risks increase. Currently, no developed country is in this critical zone. The UK’s current account deficit has improved in recent years, while France’s is small. Many European countries, as well as other highly indebted countries like Japan and China, have current account surpluses. Among the major economies, only the United States is approaching the risk zone. However, it is still far from a crisis. Regarding the holding of public debt, the United States stands out, with approximately 40% of its Treasury bonds held by foreign investors, compared to only about 13% for Japanese government bonds (JGBs).

Global Bond Yield Outlook

Considering the risk of a sovereign debt crisis to be low does not preclude potential losses on government bonds. Japanese government bonds (JGBs) are a good example. After years of yield curve control by the Bank of Japan (BoJ) to combat deflation, Japan has recently seen a significant rebound in its government bond yields, as the central bank works to create a reflationary environment. As yields have risen toward their current levels, the value of JGBs has declined, and this trend could persist in the coming months. Estimating the fair value of sovereign bonds is not easy. A simple indicator is to combine long-term inflation expectations with potential real GDP growth. If inflation stabilizes around 2%, potential growth hovers around 1% and the Bank of Japan continues to raise its key interest rates, the yield on 10-year JGBs could find its equilibrium between 2.5 and 3%, rather than below 2%.

Japan has just recorded a marked rebound in its government bond yields, as the central bank works to create a reflationary environment

The situation is more balanced in the United States, where current yields on 10-year US Treasury bonds correspond to a growth outlook of 1.9% and long-term inflation of 2.3%. 10-year UK Gilts present a similar picture, with yields of 4.5%, broadly in line with growth prospects of 1.2% and inflation of 3%. But even there, the risk of an upward movement in yields persists. A conflict in the Middle East, for example, would trigger a surge in oil prices, accelerating inflation and, consequently, causing a rise in yields on US, UK, and European sovereign bonds. This situation would exert downward pressure on performance. We believe that real assets, and gold in particular, will continue to offer greater diversification benefits than sovereign bonds in most risk scenarios.

Geopolitics and the evolution of allocations to sovereign bonds

It is becoming increasingly clear that allocations to sovereign bonds will shift due to international tensions and governments’ desire to reduce their exposure to foreign policy influence. The decline in China’s holdings of US Treasury bonds, from a peak of USD 1.3 trillion in 2013 to a historic low of USD 680 billion in November 2025, is a good illustration of this. In the BRICS countries—Brazil, Russia, India, China, and South Africa—central banks are adjusting their reserve policies in response to a less cooperative geopolitical environment, particularly regarding their relations with the United States. The Russian central bank has completely divested itself of US Treasury bonds. Faced with rising geopolitical tensions, not only between the United States and its strategic rivals like China, but also with traditional allies such as Europe and the United Kingdom, some central banks in developed countries, notably the European Central Bank, the Bank of England, and the Swedish Riksbank, may join their BRICS counterparts in increasing the share of gold in their reserves , at the expense of foreign government bonds. In this context, the share of sovereign bonds held by domestic investors is expected to increase.

Allocations to sovereign bonds will change due to international tensions and governments’ desire to reduce their exposure to foreign policy influence.

National and international investment opportunities

In several countries, sovereign bond yields now compare much more favorably with domestic equity performance than they have over the past decade. For example, we have highlighted the value that 10-year Gilts can offer UK investors, with a yield of 4.5% compared to a 5.4% earnings yield for the FTSE 100, bringing the equity risk premium – the excess return relative to sovereign bonds – down to a low of around 1%. The risk premium for Japanese equities is also at its lowest level in 10 years, at 3.1%, compared to an average of 6.5% over the period 2016-2026, underscoring the significant improvement in the value of JGBs relative to Japanese equities from the perspective of a domestic investor. In the United States, the earnings yield of the S&P 500 is lower than that of 10-year US Treasury bonds, highlighting the appeal for a domestic investor of holding US sovereign bonds.

The risk premium on Japanese stocks is also at its lowest level in 10 years, at 3.1%

Overall, our current moderate pro-risk bias leads us to maintain an underweight position in global government bonds. Nevertheless, several developed market sovereign bonds offer positive real returns. From a domestic investor’s perspective, UK Gilts, US Treasuries, Australian sovereign bonds, and increasingly, JGBs, support a long-term buy-and-hold approach. Within our sovereign bond allocations, we favor Gilts, which are expected to offer an attractive combination of income and capital gains this year. In the US, Treasury Inflation-Protected Securities (TIPS) provide protection against inflationary surprises, such as a rise in oil prices that puts upward pressure on prices. From the perspective of an international investor, and considering short-term opportunities, JGBs offer a higher return than US Treasury bonds, British Gilts, German Bunds and Swiss Confederation bonds hedged respectively in US dollars, British pounds, euros and francs.