Inflation-protected bonds have been a popular choice for investors looking to safeguard against inflation. However, recent data shows that these bonds faltered, leaving some investors scrambling to reevaluate their portfolios.
Throughout a year period, $100 put into inflation-protected Treasuries in December 2021 would have only been worth $88 a year later. This means that even cash stashed under the mattress would have yielded a better return.
Investors are taking notice of the trend and pulling billions of dollars from exchange-traded funds tied to inflation-protected bonds. Some countries, such as Canada and Germany, have even announced plans to stop issuing them altogether. But are these drastic measures necessary?
The bonds serve an important function, as they isolate and price beliefs about economic concepts. This disentangles inflation expectations and real interest rates, providing a more accurate reflection of the market’s pricing of real interest rates. For speculators, this means a more straightforward way to trade on macroeconomic pressures.
Inflation-linked bonds can offer some protection if inflation rises and central banks fail to respond by raising rates, as was seen in 2021. This means that shorter-duration inflation-linked bonds can provide payouts with lower exposure to rising interest rates, offering a viable option for some investors.
However, for bond issuers, there is a trade-off. While pension funds and other risk-averse investors may pay a premium for inflation-linked bonds, other buyers may demand a discount. The evidence on which effect dominates is inconclusive, with varying conclusions being drawn by policymakers.
Overall, inflation-linked bonds shift inflation exposure from bondholders to issuers, and markets offer compensation for those willing to take on risk. Furthermore, high inflation tends to result in a higher nominal tax take for governments, providing more money to pay down debt.
If not inflation-linked bonds, what should investors have held in late 2021 to protect against rising prices? Stocks performed worse, and while bitcoin and gold held their value, a better trade might have been betting on the price of bonds falling, including those that are inflation-linked.
In conclusion, while the recent performance of inflation-protected bonds may be cause for concern, it’s essential to weigh the benefits they offer to markets and governments. Only time will tell whether these bonds remain a viable option for investors moving forward.
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