Inflation

Inflation markets are getting back to normal after the hiatus that followed the collapse of Lehman Brothers. Then, liquidity dried up markedly as investors fled from the market, dumping capital-intensive inflation-linked bonds on their way out the door.

Luckily for the inflation markets, asset swap investors were there to take up the slack. With linkers becoming significantly cheaper versus comparable nominal government bonds, investors were able to benefit through asset swaps – essentially, buying an inflation-linked bond, swapping out the inflation component and earning a much higher return than they would have been able to achieve by buying a conventional bond. So great was the pick up, real-money investors started to step into the market, in many cases for the first time. With other sources of inflation supply drying up, this became an essential lifeline for the sector.

Dealers say the market is much improved since then, with liquidity almost back to pre-Lehman levels. In the UK, there are signs of new supply from utilities and private finance initiatives and via real estate transactions. In Europe, however, asset swappers continue to play an important role. The challenge will be to keep these investors engaged – the opportunity and returns on offer are not as great as they were last year. Dealers say many investors now have mandates and systems in place to allow them to place trades and are watching the market for new openings to emerge. Nonetheless, the perennial challenge remains – how to meet the demand for inflation. To do that, new regular sources of supply need to emerge.

Nick Sawyer, Editor

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Further reading

• Inflation markets

Losing the asset swap lifeline?

• 30 Apr 2010

• Inflation markets

A return to domestic inflation

• 30 Apr 2010

• Inflation markets

Inflation issuers face Greek fallout

• 30 Apr 2010

• Inflation markets

The inflation pricing conundrum

• 30 Apr 2010