AXA IM: Inflation linked bonds will outperform nominal bonds in current market environment
Elida Rhenals, Senior Portfolio Manager and Co-Head of Inflation, writes that president Trump’s tariffs will lead to stagflation and increased recession risks in the US. As a result, inflation-linked bonds are expected to outperform nominal bonds.
'With the combination of lower real yields and breakeven correction, we expect inflation linked bonds to outperform nominal bonds as inflation prints above market expectation in the coming months. Given the higher volatility, we decided to take profits on our US long duration positions at the 5 Yr tenor. While we expected the move in real yields to be lower, our year-end target of 1% was reached and we decided to neutralise the position. Having said this, the sell off after Chairman Powell’s remarks on 4 April, seem overdone and we are monitoring the levels to add fresh longs in the portfolio. Elsewhere, we like to hold long real yields as we see an overpricing of fiscal-induced future growth in Europe and the UK.
On Friday, oil prices declined to levels not seen since 2021 as OPEC+ announced a larger output hike in May on top of the demand shock. However, despite being an oil-driven sell off, breakeven forwards sold off and we find breakevens valuations attractive. On another note, we believe that any retaliatory tariffs put in place by the EU in response to US tariff could potentially have an inflationary impact on HICP with likely disruptions to global supply chains also increasing prices in the region. Coupled with mounting recession risks in the US, we decided to take full profits in our cross market breakeven trade of long US CPI vs HICP at the 10 Year tenor.
The tariff escalation is likely a regime shift, not a noise event, and recession risks are no longer a tail event, but a baseline. In this environment, inflation-linked bonds should offer asymmetric upside. The sharp repricing in breakevens presents a rare entry point, as inflationary pressures are structurally underpriced across major markets. Real yields are approaching levels inconsistent with deteriorating growth and tightening financial conditions, warranting a strategic re-engagement. We believe there is a clear path forward: own what benefits from structural inflation, fade growth optimism, and stay positioned for a world where volatility is the new risk-free rate. Remember, markets are conditioned for mean reversion; they are not prepared for paradigm breaks.'
