By Raffaele Prencipe,
Fixed Income Portfolio Manager DPAM


Our analysis, presented through three key graphs, illustrates the dynamics of the current inflationary environment and their impact on inflation-linked bonds.


  • In 2020, COVID lockdowns forced the supply of goods and services to drop.
  • Large fiscal deficits and loose monetary policy had the effect of boosting aggregate demand.
  • The excess of demand over supply triggered price increases.
  • Central banks in the developed world didn’t react because inflation had been low for decades.
  • In 2022, another shock: the supply of grains, oil and gas was curtailed due to the conflict between Russia and Ukraine and its related sanctions. Commodity prices rose.
  • Fiscal policy remained expansionary, but monetary policy became restrictive. As a consequence, financial conditions became restrictive too.

Figure 1: Central Banks – Policy Rates

Source: Bloomberg – February 10, 2023


  • Headline inflation is falling. For the next few months, clearing inventories of goods and energy should help bring it down further.
  • Nevertheless, it is not a straight line from here. Recently, lower gas prices in Europe and lower gasoline/petrol prices in the US have enhanced demand again. Financial conditions improved.
  • In the medium term, it is not clear how long it will take for “revenge spending” to subside and whether the labour market starts weakening.
  • In the long term, many expect a return to a state of low inflation, growth, productivity, and interest rates.
    However, several factors pose an upside risk. De-globalisation may cause a rise in costs of supply of goods. The green transition may increase demand. Central banks may increase their inflation targets from 2 to 3%.
  • A change in psychology may occur. Inflation results from decisions taken by billions of economic actors. They are influenced by their own expectations of future inflation. They may also be irrational.

Figure 2: Core Inflation Year over Year

Source: Bloomberg – February 10, 2023


  • The difference between nominal and real yields represent measures of inflation expectations: breakevens.
  • Throughout the current bout of inflation, market players have continued to believe that central banks would soon meet their 2% targets. Indeed, 5-year breakevens in the US and Eurozone never went above 3.8%. That seems a large underestimate versus an average increase in Consumer Price Indices (CPI) of over 7% in the last year and a half.
  • Inflation linked bonds outperform nominal bonds when realised inflation is higher than the breakeven at the time of purchase. If you bought a 5-year US linker on 1/1/2021, the total return to date would be above 0%. That compares to ≈ -9% for a 5-year nominal bond.
  • The return on inflation linked bonds depends on their real yield, plus the future accrual of CPI on principal and coupon.
  • Real as well as nominal yields have increased significantly. Though breakevens usually move lower in the contraction phase of an economic cycle, 2.2 and 2.3% for 10-year linkers could still be an underestimate.
  • Even with the worst behind, inflation linked bonds can play a role for protection of a fixed income portfolio.

Figure 3: Break-evens 10Y

Source: Bloomberg – February 10, 2023


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