Inflation-linked bonds - often marketed as a direct hedge against rising consumer prices - have not escaped recent market volatility. Since the Iran conflict began at the end of February, BlackRock's London-listed global inflation-linked government bond ETF has declined by roughly 2%, LSEG data show. That drop mirrors the slide in BlackRock's global government bond ETF, even as the S&P 500 climbed about 7% and reached record highs in the same period.
The tension highlights a familiar trade-off: the promise of inflation protection over the long term versus the reality of shorter-term price sensitivity when market interest rates move. Jonathan Hill, head of U.S. inflation strategy at Barclays, framed the limitation plainly: "TIPS (U.S. inflation-protected bonds) and linkers generally provide relative inflation protection versus nominal bonds," he said. "If you think that it’s a pure inflation hedge, then you’re going to be disappointed."
Inflation-linked securities are structured so that coupon payments and principal adjust with a designated inflation index, which should preserve investors' purchasing power if those securities are held to maturity. However, that mechanics does not immunize their market prices from shifts in real yields - the market interest rates adjusted for expected inflation. When central banks are expected to raise rates or when anticipated policy easing is pushed back, fixed-income instruments across the board can sell off as investors demand higher returns from new issuance. Linkers can be particularly vulnerable to such moves when their duration exposure is significant.
"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," Hill said. Duration measures a bond's sensitivity to changes in market interest rates, and longer-dated securities carry greater duration risk. That dynamic is important because an inflation spike alone does not guarantee that the market value of linkers will rise; rising real yields can offset or overwhelm the inflation indexation.
Asset managers and large institutional holders - such as pension funds - who plan to keep linkers until maturity will still receive the embedded inflation adjustments. But in the shorter timeframe, when investors trade on evolving rate expectations, prices can decline. Dorian Carrell, head of multi-asset income at Schroders, described the current environment as broadly unfavorable for fixed income: "Generally fixed income is unattractive," he said. "You’re better off looking for inflation-adjusted revenue streams, probably on the equity side" - with materials, energy and utilities mentioned as sectors offering potential inflation-linked revenue.
Not all linkers are the same, and some structures and maturities have performed better than others. BlackRock reported that investors poured $2.6 billion into inflation-linked ETFs in March - the largest monthly inflow since Russia's invasion of Ukraine in 2022 - and added another $2.2 billion in April. One reason for continued demand is the relatively stronger long-term return profile of inflation-linked assets compared with conventional bonds, particularly when inflation surprises on the upside.
Barclays' Hill noted that shorter-dated U.S. inflation-linked bonds, which face less exposure to yield swings that can negate the inflation uplift, have delivered considerably stronger returns than the broader Treasury market over the past five years. He suggested they could continue to outperform if price pressures remain elevated, a scenario he considers plausible given U.S. tax cuts and heavy investment in artificial intelligence.
But there is a cautionary note for long-dated linkers. "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.
Part of the challenge is that many inflation-linked bond markets are skewed toward longer maturities. For instance, the average maturity of Britain's index-linked gilts was 18 years in 2024, compared with 13 years for conventional gilts. That extended duration increases sensitivity to moves in real yields.
In response, some managers are seeking alternative ways to express inflation views. Marion Le Morhedec, global fixed income CIO at Fidelity International, said her team has sought protection via inflation swaps or breakevens - trades that directly target expectations for future inflation. "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."
Recent inflation prints have underscored the market's worries. U.S. inflation rose to 3.3% in March, up from 2.4% in February, as energy prices climbed in reaction to the Iran conflict. British inflation also moved up to 3.3% in March, while euro zone inflation reached 3% in April. Those increases have prompted investors to reassess the attractiveness of different assets.
Commodities have reacted strongly, with PIMCO - the world's largest bond investor - noting last week that commodities had "behaved largely as theory would suggest," recording sharp gains. Market strategists at BlackRock's Investment Institute have taken a balanced stance on linkers while favoring equities. The institute is "neutral" on inflation-linked bonds but "overweight" U.S. stocks, summarizing market sentiment: "Contained damage to global growth from the Mideast conflict and strong earnings expectations - particularly in tech - keep us risk-on."
Summary: Inflation-indexed bonds have not provided price insulation during the recent market upheaval tied to the Iran conflict. While they still offer long-term inflation protection if held to maturity, short-term price declines driven by rising real yields and duration exposure have limited their effectiveness. Some investors are turning to shorter-dated linkers, inflation swaps, breakevens or equities for inflation-adjusted returns.