Euro deflation threat crushes investors` inflation-protected bet
Baku, December 6 (AZERTAC). Tumbling inflation and a buyers` strike among hedge funds and other speculative investors is making this a loss-making year for holders of euro zone inflation-linked bonds.
But they should be back in profit next year as the currency bloc evades outright deflation and as institutions seek to diversify while protecting themselves against the longer-term risks of rising prices.
Inflation-linked bonds, known as "linkers", guarantee a return higher than the rate of inflation if held to maturity. They are popular with investors seeking safe returns with little to no risk, especially when inflation is rising.
But inflation in the euro zone fell to 0.7 percent in October, the lowest in four years and enough to make the European Central Bank cut its benchmark rate to 0.25 percent.
November`s inflation ticked up to 0.9 percent, but that still undershoots the European Central Bank`s target of "below, but close to 2 percent". It`s also lower than U.S. inflation of 1 percent and even Japan`s equivalent of 1.1 percent.
JP Morgan`s own euro zone inflation-linked index is down 0.62 percent on a total returns basis so far this year. It rose 16.37 percent last year.
Inflation-linked bonds typically account for around 5-10 percent of an average portfolio. That should remain the case next year, but if inflation remains weak, their appeal could diminish even further.
By some measures, however, linkers are expensive. Franck Triolaire, executive director and head of European inflation trading at Morgan Stanley, points to what he says is the "unjustified" premium in the forward market on 5-year linkers in five years time over cash break-even rates of around 1 percentage point.
Until that becomes apparent, investors will steer clear of these bonds and look instead to higher-yielding assets such as peripheral sovereign bonds, he said.
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