There is great excitement in bond markets in Europe with the first round of legislative elections in France today, followed by run-offs in a week’s time. The tensions are due to the loss of even a relative majority for President Emmanuel Macron in the National Assembly, as well as either the victory of Marine Le Pen’s right or a situation of impasse. For investors, a watershed to take into account when repositioning themselves on the markets. A possible answer can come with i inflation-indexed bonds.
Bond portfolios favor fixed coupons
Fixed coupon bonds are the majority component of bond portfolios. What’s better than receiving certain income streams at predetermined deadlines? This argument, however, is fine when inflation is low or stable. It becomes problematic when inflation shows a certain unpredictability; at that point, the coupons may not be able to cover at least the loss of purchasing power suffered.
Future inflation risks
Inflation in the Eurozone is declining from the highs reached at the end of 2022, although it rose to 2.6% in May. It continues to hover above target del 2%. The European Central Bank estimates that it will fall just below 2% in 2026. As long as we are talking about a few decimal points more or less than the target rate, nothing to worry about. In fact, there are several signs that reveal that things could soon get worse than expected. In the weeks before the European elections, Macron gave an interview in which he called for the revision of the ECB statute following the American example of double mandate. The policy, he explained, will have to tolerate higher inflation so as not to excessively strangle the economic cycle in the face of the need to invest heavily in favor of energy transition and in view of the ongoing “reshoring”.
Words that betray a widespread belief among governments, namely that in the coming years the paradigms on which the economy has been based in the decades of globalization.
This leads us to believe that inflation-linked bonds are still undervalued. As regards BTp€ and BTp Italia – the former linked to Eurostat inflation and the latter to Istat inflation – are respectively affected by long-term growth in consumer prices of less than 2% and just over 1%. Forecasts are optimistic to say the least, if you consider that even the arms race in the coming years it could contribute to overheating geopolitical tensions and with them the prices of raw materials.
Bonds indexed to inflation provident investment
There is also the serious possibility that Donald Trump will return to the White House after the presidential elections next November. We might hear about it again “Trumplation“that is, inflation triggered by anti-Chinese tariffs and policies to support economic growth, as well as by the repatriation of parts of the production chains that are currently outside the United States. Inflation-indexed bonds are like insurance policies. It is worth buying them when they are cheap, perhaps because the market considers a given risk to be too low. If this materializes, however, the deal will have been made by those who had shown foresight.
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