Holding bonds at times of increasing interest rates, high inflation and central banks admitting they’re unsure whether their attempts to control the situation will work, requires a strong constitution.
What’s more, one of the areas of the markets where bond managers see real opportunities – real return bonds (RRBs) – is going to be harder to access after the Canadian government announced plans to cease issuance in a November budget update that was released after Canso Investment Counsel Ltd.’s latest Canso Market Px.
Real return bonds, which were developed by Canada in 1991, are traded like normal bonds, but pay a return adjusted for inflation. They can also be used to estimate the future inflation rate that investors impute from bond yields.
That means RRBs give investors some protection from inflation – but only against unanticipated rises in inflation.
“Inflation protection should be quite valuable, given the huge depreciation over time in the value of nominal bonds, even with moderate inflation,” the bond managers said in their newsletter, calling RRBs “incredibly cheap, with effectively the same real yield as nominal bonds.”
The Canadian Bond Investors’ Association, which represents managers of more than C$1.2 trillion of fixed income assets, has asked Canada’s Department of Finance to reverse its decision to cease issuance of new real return bonds, saying it “comes at the worst possible time for investors as our economy faces a period of high inflation.”
“Now more than ever investors have greater interest in inflation-protection products as they reassess their inflation risk exposures,” the CBIA said in a statement.
“Eliminating RRBs not only reduces the diversity of funding by excluding certain market participants, but also alters the perception of all market participants that the Government of Canada is not confident that it can deal with the inflation problem, with possible serious ramifications for the Canadian dollar, Canadian interest rates and international demand for Canadian bonds.”
The CBIA says the decision was made “without holding a thorough, focused consultation with market participants,” and would make Canada the only G7 country not issuing inflation-linked bonds.
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