Indeed some think the risk of short-term deflation is more pressing, as asset prices in developed economies decline and headline inflation in the US falls. Watson Wyatt also sees deflation as a likely shortterm risk. “There is still a lot of excess capacity in developed markets, and the consumer sector is over-indebted,” Unger says. PIMCO does not see stagflation as likely, since Australia’s indebtedness is not as deep as that of other developed economies. “We don’t see inflation as being a significant problem, but that said, to the extent that inflation protection becomes cheap, we recommend that people buy it when it is cheap,” Mead says.

Unger says the risk of inflation is distant, and therefore difficult to quantify. “It’s not clear that if we have higher inflation, we’ll have higher real interest rates. If central banks start to put up interest rates aggressively, higher interest rates will hurt ILBs in the short-term.” Symon Parish, chief investment officer with Russell Investments in Australia, says investors need to remember that the price of an ILB reflects expectations of inflation, and not movements in inflation itself.

“You only get upside to the extent that inflation turns out worse (higher) than the consensus expectation at the time you bought the bond.” But the outlooks for growth and inflation are very different from the past two decades – in which the two have risen in tandem – and mark ILBs as a viable asset, Ben Alexander, principal at Ardea, says.

Essentially, they do well when growth gets hit hard and real yields fall. “Growth is at risk, and in this environment, even if inflation tacks up, the RBA may be reluctant to raise interest rates. ILBs will be one of the few assets to do well,” he says. But their long duration makes them vulnerable to economic upswings that occur during their lifespan. “The time to invest in ILBs is when you’re worried about low growth and persistent inflation, or a very specific inflation scenario, like stagflation.”

On the back of the Federal Government’s economic stimulus spending, and in response to both national and state financing needs, the Australian Office of Financial Management (AOFM) has begun increasing debt issues through existing bond lines and is tipped to put out a new ILB, which will be its first new issuance since 2003. Ardea is among the few domestic managers of ILBs.