Let’s get real – inflation-linked protection and improving index tracking

After central banks responded with substantial Quantitative Easing programs (QE), following the COVID shock in Q1 2020 and the beginning of the vaccine rollouts, demand for inflation-linked bonds has increased. 

In fixed income, investors have rotated away from safe haven government bonds, and sought inflation protection instead in the reflation trade, by switching into inflation-linked bonds. As a result, real yields on inflation-linked bonds have fallen since the end of October (despite the increase in nominal yields), and breakeven inflation (BEI) rates have risen, as Chart 1 shows for the US. Such decoupling of nominal and real yields is very unusual, and reflects the highly uncertain economic and financial regime, ushered in by the pandemic.

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