Investing.com – Analysts at BCA have introduced a framework for taking long/short positions in the Australian inflation-linked bonds (ILB) market compared to nominal government bonds. This strategy leverages the relationship between Australian ILB excess returns and inflation surprises.
BCA has coined this strategy as the “Australian Inflation-Linked Golden Rule”. The rule suggests buying Australian ILBs versus nominal government bonds when 12-month inflation expectations exceed those priced into the market. Conversely, investors should sell when their inflation expectations are lower than the market’s.
BCA’s model for Australian inflation predicts that it will fall within the range of 2.6% to 3.3% over the next 12 months. This suggests a high probability that headline inflation will exceed current market expectations of 2.6%.
Despite the small size and sometimes poor liquidity of the Australian ILB market, BCA’s empirical evidence shows a strong correlation between Australian ILB excess returns relative to duration-matched nominal government bonds and Australian inflation surprises.
Analysts suggest that with inflation expected to remain sticky in Australia, and given the current market expectations, investors should consider an overweight stance on ILBs versus duration-matched nominal government bonds over a 12-month investment horizon.
As the RBA continues its commitment to return inflation back to its target range, long-term inflation expectations are unlikely to exceed this range, making ILBs an attractive investment option.
