Why gilts have been popular investments so far in 2025

There are two sides to every story and while the headlines are awash with news of a bond market sell-off, retail investors’ appetite for gilts is picking up.

The UK Treasury last week sold £4.25 billion of five-year gilts (aka UK government bonds) at an average yield of 4.49%, with £12.74 billion worth of bids received. AJ Bell saw strong demand from its customers in this auction and the gilts attracted more money on a net flow basis than any other investment on the platform so far this calendar year.

Why rising yields could see investors trim shareholdings and switch some money into government bonds

The higher government bond yields go, the greater the competition against equities for investors’ money. At some point, investors will take the view that they can get a decent yield from bonds for lower risk compared with investing in stocks.

The yield on a 10-year UK or US government bond is often used as the risk-free rate – i.e., the theoretical rate of return for an investment with no risk. This is because neither the UK nor US government is expected to default on bond repayments, which gives their bonds supposed ‘risk-free’ status, even though they are not 100% guaranteed.

In reality, UK and US government bonds are not risk-free. If you buy at issue and hold until maturity and the borrower does not go bust or default, you get your coupons and then principal back. That’s in nominal terms. You still have inflation risk and interest rate risk, on top of liquidity risk, although the latter is not a concern if you buy at issue and hold.

UK and US government bond yields have recently risen because institutional investors have been selling the bonds, pulling down their price. However, these bonds have now reached the point where they’re starting to look more attractive, particularly to retail investors looking to lock in yields above 4%.

In the US, there is a widely held view among investment experts that yields on shorter-dated Treasuries (aka US government bonds) surpassing 5% might be the trigger point for swathes of investors to switch money from equities into government bonds. We’re not that far off given the 10-year Treasury stands at 4.785% and the five-year note is at 4.6% at the time of writing. Longer-dated Treasuries have already surpassed the 5% level including 20-year and 30-year bonds.

Rising bond yields create headwinds for equities because they increase companies’ cost of raising capital. They affect swap rates, which are estimates of future interest rates and are what financial institutions pay to acquire funding for lending. If the cost for lenders goes up, the rates they charge to customers will also increase.

Expectations for interest rate cuts from the Bank of England and the Federal Reserve continue to be pared back, and that implies higher rates for longer which is not what equity investors want to see. They want lower rates as that relieves financial pressures on consumers and businesses and gets them spending more money, which can drive corporate earnings.

Companies trading on high multiples of earnings are vulnerable to share price weakness. Rising bond yields can lead to investors being less willing to pay a premium rating for a share, leading to deratings. Many of the big tech stocks are ones to watch given their premium equity ratings.

Why are UK and US government bond prices falling?

UK bonds:

Investors are worried about extra borrowing by the UK government to achieve its plans and the uncertain outlook for the economy given widespread pessimism by businesses and consumers, hence why the pound has also fallen alongside gilt prices. Concerns that inflation could remain sticky is also a nagging factor.

Rising gilt yields have a direct impact on the UK government’s fiscal headroom as debt servicing costs have put Rachel Reeves’ fiscal rules under threat. The hike in borrowing costs narrows the chancellor’s buffer on her budget, making further tax rises and spending cuts more likely.

This situation threatens to stir up speculation that the country is headed towards recession, although that event wouldn’t be a surprise given that we haven’t had a proper one in a long time and Reeves implied from the start that things could get worse before they get better.

US bonds:

The rise in US government bond yields primarily reflects concerns about inflation, a large federal deficit and uncertain policies under a change in the administration.

Treasury yields climbed last week as stronger than expected jobs figures gave investors further reason to suggest the Fed will be slower to cut interest rates this year than previously thought as the economy is holding up well and doesn’t need looser monetary policy to get things moving.

Layer on top the potential for an increase in inflation and you can see why US equity markets have wobbled. After all, central banks typically keep rates steady or (more likely) lift them to combat inflation, implying rates in the US could stay higher for longer and that investors won’t be treated to a barrel of rate cuts.

Why would someone want to buy a gilt now?

Gilts might appeal to someone who is concerned about an impending correction in the stock market and wants to park some of their money in a lower-risk investment.

Yields of circa 4.5% on a five-year gilt are on a par with the best-buy five-year fixed rate cash savings account on the market*. Cash accounts are subject to income tax beyond the personal allowance unless held in an ISA. Gilts are also subject to income tax but they are exempt of capital gains tax.

An investor who has already used up their full ISA allowance may wish to sell some of their equity holdings and keep that cash in their account to buy gilts. Alternatively, gilts can also be bought through a pension.

Gilts might not appeal to someone who believes inflationary pressures will be strong enough to drive up interest rates again. In that situation, savings rates on cash could go up and exceed what’s available on gilts today.

In contrast, gilts might appeal to an investor who believes inflationary pressures will ease and rates will continue to come down. Locking in a yield in the region of 4.5% today on a five-year gilt could pay off if cash rates trend lower.

*Top paying five-year fixed account is Birmingham Bank at 4.55% as of 13 January 2025 (source: Moneysavingexpert).