Inflation-Linked Bonds: A Safe-Haven In 2017 ?

Leverage loans. The next trigger?

Investment in public debt has traditionally been one of the most popular fixed income assets with both retail and institutional investors. It’s considered as a safe-haven so investors can hold on to their capital. But in the last few years, it has lost part of its attraction because of lower interest rates which in some places are now in negative territory. To protect themselves, many countries like the US, Japan, the UK, France, Italy and also Spain have begun to issue inflation-linked bonds. France, which has been operating since 2001, is the biggest market for this type of product in Europe.

Similarities and differences with a nominal bond 

They are issued under the same conditions as any other public debt security. Furthermore, they also trade in an organise secondary market, which provides liquidity.

But the payments structure is different from that of a conventional bond. Both pay a fixed rate of interest as a percentage of the capital invested and pay back the principal at maturity (along with the last coupon). But in the case of inflation-linked bonds, the interest rate and the value of the investment at maturity are adjusted to the rate of inflation over the life of the security. As a result, when inflation goes up, the nominal value of the bond does the same. This is in contrast to nominal bonds, which lose value when inflation rises.

For sovereign bonds and debentures index-linked to European inflation, the Harmonised Index of Consumer Prices (ex-tobacco) is used. This is published monthly by Eurostat.

This is a product for conservative investors who want to cover themselves against inflation. The most interesting thing is the floor clause which, in the case of a scenario of deflation, prevents the capital at maturity from being below the original investment. If inflation in one year was negative, the coupon obtained could never be negative. If inflation was negative during the life of the bond, then at maturity at least the capital invested would always be returned.

Spain began to issue inflation-linked bonds in 2014. Since then, the Treasury has organised 21 issues of this kind at 3, 5, 10 and 15 years for a total of 28.588 billion euros, which is 7.2% of the total of bonds and debentures awarded over this period (398.651 billion euros). The real interest rate (discounted for inflation) has varied between the 1.84% on those issued in May 2014 to the 0.584% on those issued in December 2016. This rate is an average taken from the different terms issued and is applied with a lag of three months so that the inflation rate is definitive and no adjustments have to be made later.

In principal, there is an inflation-linked bond issue the first Thursday of each month, although it is still not confirmed whether there will be another issue on February 2.