Sandrine Soubeyran, Global Investment Research, FTSE Russell
As economies recovered from the Covid-19 pandemic, investors have rotated away from conventional government bonds and sought inflation protection in the reflation trade by switching into inflation-linked bonds. As a result, yields on inflation-linked bonds (IL) fell sharply. As can be seen in Chart 1, after an initial spike in March 2020, WGBI inflation-linked bond yields dropped to as low as minus three (in the 1-3-year area) and still remained well below zero in longer maturities.
Charts 1: Global WGBI real yields have fallen to three-year lows
Source: FTSE Russell, from December 31, 2019 to April 30, 2022.
Unlike real yields, nominal yields have risen sharply during the same period, pushing breakeven inflation to multi-year highs. Central banks had been more accepting of inflation running above-target levels during the pandemic, and there were fears this accommodative stance would extend during the war in Europe. Even so, the increase in value of IL bonds and the decoupling of nominal and real yields were unusual.
All change since 2022
However, since January 2022, real yields have mirrored the rise in nominal yields and become less negative. Chart 2 shows that inflation had already begun to build up in the second half of 2021 as economies recovered from exiting lockdowns. However, the impact of sanctions and the war in Ukraine drove energy and food prices to new highs. In response (and contrary to initial investor concerns), central banks signalled their inflation-fighting stance (including further quantitative tightening) and began the process of raising policy rates, which further pushed up nominal yields.
Chart 2: Global nominal yields are at their highest in three years
Source: FTSE Russell, from December 31, 2019 to April 30, 2022.
As a consequence, the biggest move came from the short end, where the yield gap between sovereign and comparable IL bonds (breakevens) have widened the most, followed by the 7-10-year area (see Chart 3). However, although inflation-linked bonds became relatively more expensive, as reflected by the higher breakeven levels, nominal rates increased even more. Like conventional bonds, inflation-linked bonds are affected by changes in interest rates. So even though inflation linked bonds have benefited from rising inflation, the price can be more than offset by the impact of rising interest rates as witnessed since Q1 2022.
Chart 3: Inflation breakevens rise to their highest levels since 2018
Source: FTSE Russell, from December 31, 2018 to April 30, 2022.
Rising interest rates impacted inflation-linked bonds returns
Consequently, returns for inflation-linked bonds have been broadly negative since January, as longer dated nominal yields have adjusted higher. As Chart 4 shows, short-dated IL bonds held up best in both April and since January, while their longer counterparts suffered the most, including double-digit losses in the UK and Germany.
Inflation-linked bonds are designed to help protect investors from the negative impact of inflation by contractually linking the bonds to a recognized inflation measure such as the CPI in the US. Therefore, their success relative to conventional bonds also depends on inflation expectations.
Chart 4. Longer maturities see the worst of the sell-off, both in April and YTD
Source: FTSE Russell, data as of April 30, 2022. Past performance is no guarantee to future results. Please see the end for important disclosures.
For more information on inflation-linked bonds subscribe to our blog.
© 2022 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) FTSE Fixed Income Europe Limited (“FTSE FI Europe”), (5) FTSE Fixed Income LLC (“FTSE FI”), (6) The Yield Book Inc (“YB”) and (7) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “FTSE4Good®”, “ICB®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this document should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset or whether such investment creates any legal or compliance risks for the investor. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset nor confirmation that any particular investor may lawfully buy, sell or hold the asset or an index containing the asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This document may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, FTSE FI, FTSE FI Europe, YB, BR and/or their respective licensors.
