Latest fraudulent alert - last updated on Apr 2023. To find out more information and how to protect yourself, please click here.

Investment Institute
Fixed Income

Why now may not be the time to sell inflation-linked bonds

  • 17 May 2023 (5 min read)

Key points: 

  • The move away from inflation-linked bonds is expected but potentially misplaced.
  • Why investors may want to re-evaluate their inflation-linked bond allocation
  • What inflation-linked bonds offer in this market environment

Inflation-linked bonds tend to be at the sharp end of investor behaviour: investors pile in as inflation takes off and then disinvest when nearing the peak regardless of what the inflation level is. This current inflationary cycle has been no different and investors began moving away from inflation-linked bonds towards the end of 2022 as the headline inflation peak was anticipated. This trend continues today. 

The challenge for investors, however, is that inflation is still high even by historic standards and, while headline inflation may have fallen from the extremes of this time last year, core inflation remains elevated.  Inflation is sticky and we expect it may be a problem for the next decade. Factors that might see inflation remaining sticky such as the green revolution, the continuing supply strains on resources caused by the war in Ukraine and budget deficit concerns mean inflation levels could remain volatile for the foreseeable future. 

Nevertheless, as the chart below shows, economists are still projecting a return to around the 2% target levels by the end of 2023..

Image
Image

Source: AXA IM Forecasting as of June 2023. The above represents our current market views only and does not constitute investment advice. 

Added to this, the 10Y inflation breakevens suggest that the market is pricing future inflation at similar levels to those seen between 2010 and 2013.

Image
10y inflation swaps

Source: AXA IM, Datastream as at 16/05/2023 

Market conditions offering opportunities

We expect that yield curves will remain inverted with overnight interest swap markets (OIS) pointing to US rates at 3.8% in 2-years’ time, Euro rates at 3.1% and sterling overnight rates at 4.4%1 . As an inverted yield curve has historically been followed by a yield rally, market signals are making a stronger case for duration than we’ve seen for a while. Considering this expectation of a duration rally once core inflation turns, adding duration as core inflation rolls over may be an interesting opportunity.  

When inflation moderates, inflation breakevens tend to go down but this combination of elevated levels of real yields and moderate level of breakevens is where we see opportunities. Inflation-linked bonds’ average real yields are currently at their highest average level since 2009-2010 but they are positive suggesting that investors can lock-in an above inflation income.  

Image

We believe that the combination of this with the market complacency towards future inflation risks suggests that inflation-linked bond investors may be able to lock-in positive real yields at their highest level post Lehman while getting exposure to inflation breakevens, (effectively a form of insurance premium against future inflation) at historically attractive levels.

With inflation likely to be volatile for the foreseeable future, inflation-linked bonds may be a useful tool for investors: they provide resilience against sticky inflation and, as all inflation linked bonds cashflows are indexed to inflation and their issuers are often highly rated sovereigns, investing in inflation-linked bonds may be used as part of an investor’s capital preservation strategy.

  • U291cmNlOiBCbG9vbWJlcmcsIE1heSAyMDIz

Related Articles

Fixed Income

Top Three Green Bond Myths

  • by Edgar Mehrabyan
  • 15 March 2024 (5 min read)
Fixed Income

Why ETF investors should not overlook active fixed income

  • by Gonzague Hachette
  • 13 March 2024 (5 min read)
Fixed Income

US High Yield Quarterly Outlook - January 2024

  • by Mike Graham
  • 05 February 2024 (3 min read)

    Disclaimer

    This website is published by AXA Investment Managers Asia Limited (“AXA IM HK”), an entity licensed by the Securities and Futures Commission of Hong Kong (“SFC”), for general circulation and informational purposes only. It does not constitute investment research or financial analysis relating to transactions in financial instruments, nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy, sell or enter into any transactions in respect of any investments, products or services, and should not be considered as solicitation or investment, legal, tax or any other advice, a recommendation for an investment strategy or a personalised recommendation to buy or sell securities under any applicable law or regulation. It has been prepared without taking into account the specific personal circumstances, investment objectives, financial situation, investment knowledge or particular needs of any particular person and may be subject to change at any time without notice. Offering may be made only on the basis of the information disclosed in the relevant offering documents. Please consult independent financial or other professional advisers if you are unsure about any information contained herein.

    Due to its simplification, this publication is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee such opinions, estimates and forecasts made will come to pass. Actual results of operations and achievements may differ materially. Data, figures, declarations, analysis, predictions and other information in this publication is provided based on our state of knowledge at the time of creation of this publication. Information herein may be obtained from sources believed to be reliable. AXA IM HK has reasonable belief that such information is accurate, complete and up-to-date. To the maximum extent permitted by law, AXA IM HK, its affiliates, directors, officers or employees take no responsibility for the data provided by third party, including the accuracy of such data. This material does not contain sufficient information to support an investment decision. References to companies (if any) are for illustrative purposes only and should not be viewed as investment recommendations or solicitations.

    All investment involves risk, including the loss of capital. The value of investments and the income from them can fluctuate and that past performance is no guarantee of future returns, investors may not get back the amount originally invested. Investors should not make any investment decision based on this material alone. 

    Some of the services listed on this Website may not be available for offer to retail investors.

    This Website has not been reviewed by the SFC. © 2023 AXA Investment Managers. All rights reserved.