Inflation linked bond market soars, but longer maturities warrant caution – AXA IM
David Dyer, senior portfolio manager at AXA Investment Managers considers the recent issuances contributing to a burgeoning global inflation-linked market and notes investors should exercise caution around longer maturities.
The inflation linked bond market is a much younger market than the nominal bond market, and due to its shorter history, the market does not yet have the same variety and depth as the nominal one. However, the global inflation-linked market is developing at a rapid pace.
Most notable in recent weeks was the longest ever inflation bond, a 55 year issue from the UK, on 24 September 2013. The UK Government first indicated a desire to significantly extend its debt profile last year and this £5 billion issue, that was 2.2 times oversubscribed, followed the success of a similarly-dated conventional gilt in June. The issue undoubtedly proved a hit with UK pension funds who wish to match long-dated inflation liabilities, whilst the UK Government funded at a real yield of just 0.14% for over half a century.
Japan has also returned to the market and saw very strong demand for a new 10 year issue on 8 October 2013. This was the country’s first linker issuance for five years and was also the first with a clause that protects the investor against deflation over the lifetime of the bond. The key question for this market is whether this will ultimately lead to domestic interest as previous issues have been dominated by overseas demand. Indeed with international investors heavily involved in this auction, initial liquidity may be limited.
Furthermore, also on 8 October 2013, New Zealand also extended their issuance curve with a new 2030-dated issue. Again demand was strong leading to a higher than expected issuance size, aided by the recent announcement that the growth of the New Zealand market has seen it reach a size where it is eligible for inclusion in major global inflation indices. This followed Australia also extending its inflation curve when they issued a 2035 maturity a couple of weeks earlier on 26 September 2013. In the emerging markets universe, following India’s first issue in June, the Philippines is expected to follow before the end of the year.
Meanwhile the more established markets continue their issuance programmes with Germany issuing a five year linker and (despite the government shutdown), the US scheduling a 30 year TIPS issue next week. Italy has also just announced that next month will see the issue of another bond in the BTP Italia series linked to Italian inflation, which have previously proved very popular with domestic investors.
All this extra issuance has provided a wider opportunity set for investors in the global inflation markets. However with governments increasingly concentrating issuance towards longer maturities, investors need to exercise caution about slavishly following them. Although the recent surprise US decision not to taper bond purchases has halted the rise in bond yields for now, there is still a potential for capital losses if yield rises resume.