BlackRock’s Linker Demand Looks Past Europe’s Subdued Inflation

Italy's inflation-linked government bonds are outperforming conventional securities by the most in three years as investors disregard subdued increases in consumer prices in their hunt for value in euro-region debt markets.

Italian index-linked bonds returned 8.6 percent this year through yesterday, exceeding the 7.5 percent gain on nominal securities, according to Bank of America Merrill Lynch indexes. Investors at 
BlackRock Inc. (BLK), the world's largest manager, and Henderson Global Investors say they're turning to the linkers, judging that the rally in the broader market is running out of steam.

“There is more focus on relative value and specific assets that we like rather than the wholesale idea peripheral markets are going to rally,” Chris Allen, a London-based money manager in BlackRock's euro fixed-income team, said in a telephone interview on May 1. The company, which has more than $4 trillion in assets under management, shifted its focus to investments including Italian inflation bonds after reducing holdings of 10-year Spanish and Italian securities in the first quarter of the year, he said.

Demand for the securities, whose payments are tied to changes in consumer prices, is a boon for the Italian and Spanish governments as they diversify funding sources to spread repayment risks. Spain raised 5 billion euros ($6.83 billion) in its inaugural sale of the securities this week. While inflation is languishing at less than half the European Central Bank's goal, a recovery in living costs would boost returns for investors at the expense of the issuing nations.

Tumbling Yields

The 1.1 percentage point gap between returns on Italy's inflation bonds and conventional securities is the widest for the start of the year since 2011. Italian 10-year yields increased three basis points, or 0.03 percentage point, to 2.94 percent as of 12:45 p.m. London time after falling to a record-low 2.885 percent, down from more than 4 percent at the start of the year. Ten-year linkers yielded 1.64 percent before inflation, down from 2.78 percent in December.

Italy sold about 26 billion euros of linkers this year, 20.6 billion euros of six-year inflation-linked bonds known as BTP Italia.

“We've been involved in the inflation-linked market in Italy and also the domestic inflation-linked market, the BTP Italia,” BlackRock's Allen said.

Today's Data

A report today confirmed consumer prices in the euro area rose 0.7 percent in April from a year earlier, less than half the ECB's goal of just below 2 percent. The ECB is preparing multiple measures against too-low inflation that could be used as soon as next month, central bank policy makers said yesterday.

“Shorter-dated inflation-linked bonds in the periphery are beginning to look like a better risk-reward here than longer-dates peripheral debt,” said James McAlevey, head of interest rates at Henderson in London, who helps manage the equivalent of $133 billion. “Inflation as an asset class in Europe is very under-owned, not surprisingly given recent underperformance of inflation.”

ECB stimulus designed to boost inflation may yet give a fillip to conventional securities by holding down borrowing costs, enabling the securities to continue this year's rally.

Read more: BlackRock's Linker Demand Looks Past Europe's Subdued Inflation

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