Inflation-linked bonds, often promoted as protection against rising prices, have struggled alongside the broader bond market as the war involving Iran fuels inflationary pressures across the global economy. At the same time, surging equity markets have continued to attract investor attention.
Since the conflict erupted at the end of February, BlackRock’s London-listed global inflation-linked government bond ETF has declined by roughly 2%, according to LSEG data. That performance closely matches losses seen in the asset manager’s global government bond ETF, while the S&P 500 has climbed 7% and reached record highs this week.
Rising Rates Undermine Traditional Inflation Protection
“TIPS (U.S. inflation-protected bonds) and linkers generally provide relative inflation protection versus nominal bonds,” said Jonathan Hill, head of U.S. inflation strategy at Barclays. “If you think that it’s a pure inflation hedge, then you’re going to be disappointed.”
Inflation-linked bonds are designed to preserve investors’ purchasing power over the long term because their payments are tied to inflation indices. However, in shorter timeframes, they remain vulnerable when markets expect central banks to raise interest rates or delay previously anticipated rate cuts.
As yields rise, the fixed income generated by existing bonds becomes less attractive compared with newly issued debt carrying higher returns. Inflation-linked securities are therefore not immune to broad bond market selloffs.
Large institutional investors such as pension funds that hold these securities until maturity can still benefit from their inflation-adjusted payouts. Yet in the near term, prices can weaken when real yields — interest rates adjusted for expected inflation — increase.
“If inflation goes up, but real yields go up as well, then the duration side of the bond sells off the same as all bonds,” said Hill. Duration refers to a bond’s sensitivity to changes in interest rates, with longer-dated securities typically more exposed.
Investors Shift Toward Equities and Commodities
“Generally fixed income is unattractive,” said Dorian Carrell, head of multi-asset income at Schroders. “You’re better off looking for inflation-adjusted revenue streams, probably on the equity side” — with materials, energy and utilities presenting opportunities.
Investors have increasingly gravitated toward sectors expected to benefit from inflation and commodity price strength, while global stock markets continue to rally strongly.
Shorter-Dated Linkers Attract Interest
Despite the recent weakness, some investors remain interested in inflation-linked bonds. BlackRock data showed that $2.6 billion flowed into inflation-linked ETFs during March, marking the largest monthly inflow since Russia invaded Ukraine in 2022. Another $2.2 billion was added in April.
Part of the appeal comes from stronger long-term performance relative to conventional government bonds. Barclays’ Hill noted that shorter-dated U.S. inflation-linked securities have delivered significantly better returns than the wider Treasury market over the last five years because they are less exposed to sharp moves in yields that can outweigh inflation adjustments.
He added that persistent price pressures tied to factors such as U.S. tax cuts and heavy investment in artificial intelligence could continue to support these securities. Inflation-linked bonds also tend to outperform regular bonds when inflation rises unexpectedly.
“As we’ve seen in the past, short-dated linkers may well work, but long-dated linkers can carry too much duration in an inflation-induced bond market sell-off,” said Lloyd Harris, head of fixed income at Premier Miton Investors.
Portfolio Managers Seek Alternative Inflation Hedges
Many inflation-linked bonds have relatively long maturities. In Britain, for example, the average maturity of index-linked gilts reached 18 years in 2024, compared with 13 years for conventional government bonds.
Marion Le Morhedec, global fixed income CIO at Fidelity International, said her team has instead been using inflation swaps and breakeven trades to express views on future inflation trends more directly.
“The question is really how long this inflation uncertainty will remain,” she said. “Definitely what we are doing in our portfolios is really to keep those short-dated inflation protections.”
Inflation has accelerated in several major economies following the spike in energy prices linked to the Iran conflict. U.S. inflation rose to 3.3% in March from 2.4% in February, while UK inflation also climbed to 3.3% in March. Inflation in the euro zone increased to 3% in April.
Market Momentum Continues to Favor Risk Assets
As inflation concerns intensify, investors have also looked toward assets benefiting directly from higher commodity prices. Bond giant PIMCO noted last week that commodities had “behaved largely as theory would suggest,” posting strong gains during the recent turmoil.
Meanwhile, BlackRock’s Investment Institute said it remains “neutral” on inflation-linked bonds while maintaining an “overweight” position in U.S. equities.
The firm summarized current investor sentiment by saying: “Contained damage to global growth from the Mideast conflict and strong earnings expectations — particularly in tech — keep us risk-on.”
