Swedish inflation-linked bonds may be understating the risk of price gains in the largest Nordic economy as most forecasters, including the central bank, predict inflation will outpace market bets.
The breakeven rate on Sweden’s 10-year inflation-linked bonds shows investors expect annual inflation of 1.55 percent over the next decade, compared with an average of 1.84 percent since the global financial crisis erupted in 2007. The Riksbank forecasts inflation will reach 2.7 percent by the end of 2014.
“When breakevens have been at these levels, traditionally it has been a buy,” Martin Tallroth, an interest rate strategist at Swedbank AB in Stockholm, said in an interview. “Index-linked bonds look cheap relative to the nominal bonds.”
Swedish inflation-linked bonds have underperformed regular debt over the past year as investors snapped up the government’s nominal bonds to seek refuge from the euro area’s debt crisis. Swedish linkers returned 11.67 percent over the past year, compared with a 13.22 percent return on the country’s regular bonds, according to Barclays Capital indexes.
Breakeven rates hit a low of 1.24 percent in November, and have historically risen more than 1 percentage point after reaching a trough over the past five years.
Caused By Fear
Sweden’s 10-year breakeven rate is the lowest after Italy, which may be in its fourth recession since 2001 as the euro- area’s third-largest economy cuts spending to reduce debt. It is also lower than Germany’s 1.85 percent 10-year breakeven and the U.K.’s 2.73 percent, even as growth in largest the Nordic economy is estimated to outpace its larger European counterparts both this year and next, according to the Organization for Economic Cooperation and Development.
“In the short-term, inflation in Sweden will be low and possibly below expectations, but in the medium to long term, breakeven levels look lower than fair value,” Mats Hyden, chief economic strategist at Nordea Bank AB (NDA), said by telephone. “That is likely caused by fear in the current risk-aversion environment.”
The Swedish debt office has about 215 billion kronor in outstanding inflation-linked bonds, less than half of its regular debt. The debt office plans to issue about 6 billion kronor a year in inflation linked bonds.
Five-year government bond yields were trading at 1.21 percent today, up from a 20-year low of 1 percent on Jan. 16. The equivalent index-linked note is trading at a yield just below zero. The nominal yield on an inflation linked security is calculated by adding the rate on the consumer price index.
“Inflation will be low, but excluding a collapse in oil and electricity prices and even more drastic rate cuts than currently discounted, inflation is unlikely to become negative,” Jussi Hiljanen, chief fixed income strategist at SEB AB in Stockholm, said by phone.
A survey by Fitch Ratings of bond investors in Sweden showed 60 percent expect the Nordic region to avoid a recession even as 88 percent of those surveyed also expect the crisis will continue as is or worsen. The Riksbank expects economic growth of 1.3 percent this year and 2.3 percent next year.
Riksbank Governor Stefan Ingves said in the minutes of the bank’s December rate meeting that policy makers are now in “wait-and-see mode” on rates. Investors surveyed by TNS Sifo Prospera are betting the bank will cut rates to 1.4 percent by the end of 2012. The bank said Dec. 20 it will keep the benchmark rate low to help bring inflation back to its target.
“We expect that the Riksbank will cut the rate to 1 percent by the summer,” said Per Sellden, an analyst at Stockholm-based Swedbank AB. (SWEDA) “From the point of view of inflation, there should be no problem to lower the rate.”
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