Mitigating inflation risks

After decades of benign inflation, it has reemerged as a major concern to investors. The rate of annual inflation has increased substantially in 2022, reaching a peak of 9.1% in the US and 10.6% in the Eurozone. Inflation erodes purchasing power and hence it constitutes an investment risk. Fortunately, there are ways to mitigate this risk which can be achieved with inflation-linked bonds or inflation-linkers, as they are also called.

Inflation linked bonds are Treasury bonds which means they have the same credit quality as nominal bonds issued by the same country. An inflation linked bond explicitly provides investors with compensation for inflation. It is ensured with indexation of its principal amount to a specific inflation index. If inflation is positive, the principal increases, while in the case of deflation, it decreases.

Inflation-linkers also pay a coupon which is set as a fixed percentage of the adjusted principal. Positive inflation from the time of bond issuance to a coupon payment date will translate into a proportionally higher coupon payment. In the case of deflation, the coupon will be calculated on the lowered adjusted principal.

Read more on inflation-linked bonds in our latest On-Track-Research publication.