How Geopolitics Affect Government Bond Markets

As geopolitical risks become a more prominent consideration for investors, attention has naturally turned to government bond markets and other asset classes that have historically helped cushion portfolios during periods of market stress. For decades, high-quality government bonds, particularly those issued by countries with strong credit ratings, have been regarded as a cornerstone defensive allocation.

Geopolitical events affect government bond markets through several channels, including changes in inflation expectations, capital flows, currency demand, and the credibility of fiscal and monetary institutions. Whether government bonds act as effective defensive assets during geopolitical stress depends not only on the presence of uncertainty, but on the nature of the shock and the policy response it provokes.

Historically, developed market government bonds have often tended to perform strongly during these periods. Investors have generally been able to expect the timely receipt of coupon payments and full repayment of principal at maturity. In practice, outright defaults by developed market governments are rare. However, the risks investors face can differ meaningfully across countries depending on institutional frameworks and whether debt is issued in a sovereign’s own currency. For sovereigns that issue debt in their own currency, monetary flexibility and the ability to finance obligations in domestic currency can reduce default risk, but it may also shift risk toward inflation and currency valuation changes.

Three key characteristics have traditionally underpinned the defensive role of government bonds during periods of geopolitical stress:

• Low correlation with risk assets during periods of market stress
• Highly liquid and easily tradable
• Strong policy frameworks and institutional stability that support long-term confidence.

Unlike some alternative defensive assets, government bonds are not constrained by limited supply, allowing them to better absorb shifts in investor demand during periods of heightened uncertainty.

Are government bonds still perceived as effective safe havens^Footnote1?

Recent history highlights that the defensive behaviour of government bonds is not static. The COVID‑19 pandemic delivered an unusually large and synchronised global shock, combining aggressive policy stimulus with severe supply disruptions. In this environment, government bonds at times moved in tandem with equities, particularly as inflation pressures intensified and interest rates rose sharply.

This experience contrasted with the low‑inflation backdrop that prevailed for much of the previous few decades, when government bonds more consistently provided diversification during periods of equity market stress.

However, when inflation pressures begin to ease and economic conditions stabilise, the traditional diversification benefits of government bonds tend to re-emerge. Following the inflation peak of 2021–2022, correlations between bond and equity returns have moved back towards neutral – and in some cases negative – although they remain somewhat higher than prepandemic levels.

These developments suggest that the relationship between bonds and equities is increasingly influenced by the broader macroeconomic environment, particularly trends in inflation. Rather than representing a permanent shift in correlations, these episodes highlight the importance of understanding the conditions under which government bonds are most likely to provide defensive benefits.

Against an increasingly complex and unpredictable geopolitical backdrop, several government bond markets continue to display attributes that may support their role as effective portfolio hedges.

Switzerland: Swiss government bonds remain among the most credible defensive assets globally, underpinned by:

• AAA sovereign rating
• Long-standing political neutrality
• Strong fiscal position
• Structurally low inflation

Swiss government bonds also benefit from being priced in Swiss francs, which have historically been viewed as a refuge during periods of geopolitical stress. Indeed, increased international capital inflows into the country during periods of extreme risk aversion has supported bond valuations even when yields have been low.

Japan: Another traditionally defensive market, Japan benefits from:

• A large and loyal domestic investor base
• Deep and liquid sovereign bond markets
• A central bank with a demonstrated willingness to intervene to maintain market stability

The Bank of Japan’s policy framework has played an important role in managing volatility during periods of stress.

Europe/Germany: German government bonds (Bunds) continue to serve as the cornerstone of the eurozone government bond market. Their defensive attributes include:

• Strong fiscal credibility
• High market liquidity
• The relative stability of the euro currency

However, historical evidence suggests that Bunds may be most defensive during Europe-specific shocks rather than global crises.

U.S.: U.S. Treasuries continue to offer significant defensive qualities:

• Denominated in the world’s reserve currency
• Deep and diverse investor base
• A strong legal and institutional framework

Short‑dated U.S. Treasuries, in particular, have often attracted increased demand during periods of geopolitical uncertainty due to their liquidity and lower interest rate sensitivity.

Structural trends suggest that geopolitical uncertainty is likely to remain a persistent feature of the global investment landscape. In this environment, government bonds have continued to play an important role in diversified portfolios.

While their behaviour has become more nuanced, government bonds continue to offer liquidity, diversification, and the potential for positive performance during deflationary or risk‑off periods. For investors, the key lies in selectivity – understanding which government bond markets are best positioned to provide defensive benefits in different geopolitical and macroeconomic scenarios.

As the traditional inverse relationship between bonds and equities has begun to re‑establish itself in some environments, balanced portfolios can once again benefit from more complementary asset class exposure. This supports the pursuit of long‑term returns while helping to manage overall portfolio volatility.