Examining the Merits of Inflation Linked Bonds

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Examining the Merits

Thant Han

Thant Han - Portfolio Manager - Global Fixed Income Strategies

At the beginning of year, volatility in the oil and commodity complex had markedly increased, along with the fatter tail risk of a hard landing for China. In a global context, market sentiment was characterized by fears of deflation and a weaker growth profile, putting further onus on monetary expansion polices, especially those of the European Central Bank (ECB) and Bank of Japan (BOJ). Similarly, it has led the US Federal Reserve (Fed) to be more patient and cautious around raising interest rates. At the time, the five-year US breakeven inflation rate, defined as the difference between the five-year US Treasury bond yield and the five-year US Treasury inflation-protected securities (TIPS) yield, fell below 1%. Heading into 2017, global deflation risks have materially subsided. G10 headline inflation measures have broadly shifted higher, via positive base effects from oil price normalization, and have surprised markets to the upside. Both breakeven inflation rates and forward market-based measures of inflation expectations have begun to adjust.

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