The first Eurozone inflation indexed bond (OATei) auctioned in October by the French Trésor has been very well received. Demand was seen not just from within the domestic market but also from the rest of Europe and as well as the UK and the US. As well as the Anglo Saxon issuers, the UK, US, Canada and Australia, Sweden and France have also issued inflation indexed government debt. The French Government has been issuing inflation-protected debt since 1998, but this issue is the first bond that is linked to the Euro-zone harmonised consumer price index excluding government controlled tobacco prices.
“This is a development that I wholly applaud,” states Skandia’s Christer Kack. “In today’s market with such an unclear picture for both bonds and equities, it is a sensible thing to consider this type of asset. The global economy is getting a huge amount of stimulus just now and especially in the US from monetary and fiscal policies and a falling oil price. If we do see growth, there may or may not be an inflation stimulus accompanying it and index linked bonds are there to compensate you for this. I would admit that most index-linked markets, like ours in Sweden are less liquid than cash bonds but they can be used as trading instruments. Also they are not as volatile as conventional debt and can be used to lower the standard deviation of your portfolio.”
Barclays Global Investors Peter Day, head of single currency fixed income portfolio managers agrees that the French Government’s move is a smart one and a good portent for the market. “The previous inflation indexed OAT (OATi) was pretty illiquid, not least because of its fairly limited appeal,” he argues. “The investor base was narrow: who outside of the French insurers would be needing to buy an asset that was linked to French inflation? The French Trésor have made it known that they are keen to enhance the liquidity in the index linked market and are planning a fairly regular programme of issuance. They would like to see a curve of index linked bonds. But I think it is fair to say that it will still take some time to build a truly liquid market.
“The US TIPS (Treasury Inflation-Protected Securities) market is the only really liquid one in the world right now,” adds Day. “Even here in the UK, where index linked Gilts have been in issuance for 20 years, the liquidity is poor primarily because the investor base is small. The natural buyers are limited to pension funds and insurance companies, and there is a tendency for them to buy and hold. And as investors tend to move in unison, either in response to regulatory changes or asset allocation changes.”
It seems likely that other governments will follow the lead of the French and take to issuing these broader inflation-indexed bonds. The French authorities believe that eventually index-linked bonds will be bought and sold by pension and insurance funds across Europe, by banks, corporates and even the hedge and arbitrage investors. “With such a diverse group of potential investors, there is every reason to believe that index linked markets everywhere will see improved liquidity,” argues Barclays’ Day, adding, “And it should help other index linked markets such as the UK by increasing investor awareness and interest generally.”
Karl Bergqwist, head of fixed income credit investment at BGI, adds that it seems likely that the issuer base in the UK will also broaden. “It makes sense for those companies, such as the utilities, airport operators or telecoms, who are regulated on an RPI (Retail Prices) basis to think about issuing index-linked bonds.”
“Index linked bonds should be popular because of their inherent low risk,” says Skandia’s Kack, “and giving an investor a clear picture of the real return and compensating for any inflation that may appear has to be a good thing in these troubled times.”