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TIPS Drive Away Biggest Bond Bulls Seeing Inflation (Update3)
2010-02-16 13:57:15.514 GMT
(Updates Barclays TIPS sales forecast in 24th paragraph.)
By Oliver Biggadike and Daniel Kruger
Feb. 16 (Bloomberg) -- Treasury Inflation-Protected
Securities are posting the biggest losses since Lehman Brothers
Holdings Inc. collapsed in 2008 as investors say they’re too
expensive when consumer prices are barely rising.
Blackrock Inc., Pacific Investment Management Co. and FAF
Advisors Inc., which oversee about $4.5 trillion, are selling
TIPS, contributing to a 1.1 percent loss this month after they
gained 1.5 percent in January and 10 percent in 2009. The bonds
are on pace for their worst month since falling 8.47 percent in
October 2008, the month after Lehman went bankrupt.
Investors who were piling into TIPS as recently as four
months ago on concern that a recovering economy and $8.2
trillion of U.S. stimulus spending would ignite inflation are
reversing course. They see little need to protect against price
increases as the dollar rallies, banks restrict credit and
expanding government deficits around the world threaten to slow
global growth.
“I’ve been a pretty aggressive seller in the last month or
so,” said Mihir Worah, who manages Newport Beach, California-
based Pimco’s $15.6 billion Real Return Fund, the largest TIPS
fund. “Over the next year I see inflation south of 1 percent.”
At least for now, a slow-growing economy, which Pimco calls
the “new normal,” and declining inflation concerns in the bond
market may reduce pressure on Fed Chairman Ben S. Bernanke and
President Barack Obama to rein in stimulus measures. That may
change when investors start to pressure the government into
dealing with budget deficits that the administration estimates
will reach $4.3 trillion during the next five years.
Fed’s Take
“Household spending is expanding at a moderate rate but
remains constrained by a weak labor market, modest income
growth, lower housing wealth, and tight credit,” the central
bank’s Federal Open Market Committee said after its last policy
meeting on Jan. 27. “Inflation is likely to be subdued for some
time.”
Bonds linked to inflation are losing around the world. A
Bank of America Merrill Lynch index measuring returns on similar
securities issued from the U.K. to Australia is down 1 percent
this month, the worst performance since last February, when the
market fell 2.5 percent.
The U.S. government is likely to release data this week
showing inflation remains in check. Excluding food and energy,
consumer prices in the U.S. rose 0.1 percent in December, the
Labor Department said Jan. 15. That’s less than the 0.2 percent
average of the last decade. The agency may say Feb. 19 that
prices again rose 0.1 percent in January, according to the
median estimate of 61 economists surveyed by Bloomberg.
Breakeven Rates
TIPS pay interest on a principal amount that rises with
consumer prices. Their face value is protected against
deflation, because the principal can’t fall below par. The
benchmark 1.375 percent 10-year Treasury-Inflation Protected
Security due January 2020 yields 1.46 percent as of 8:48 a.m. in
New York.
That’s 2.25 percentage points less than Treasuries of
similar maturity that don’t provide protection from rising
prices. The difference, known as the breakeven rate, reflects
the pace of inflation investors expect over the life of the
securities. The spread has fallen from the peak this year of
2.49 percentage points on Jan. 11.
Worah was buying TIPS as recently as October as the dollar
fell and the Fed and lawmakers showed no urgency to withdraw
stimulus money. Since November, the U.S. currency as measured by
the Bloomberg Correlation-Weighted Index has risen about 6.2
percent from a 15-month low. A strengthening dollar reduces the
cost of imported goods, damping inflation. He’s buying German,
Australian and Canadian inflation-linked debt instead.
Relationship Upended
The financial crisis upended the traditional link between
TIPS and consumer prices. In 2008, with inflation at 3.85
percent, investors switched to Treasuries and abandoned TIPS as
the bankruptcy of Lehman boosted demand for securities that were
easiest to trade. Inflation-protected securities posted the
first annual loss since their creation in 1997, falling 1.13
percent, Bank of America Merrill Lynch bond indexes show.
Higher consumer prices are inevitable, as the rising U.S.
budget deficit weakens the dollar, according to Mark MacQueen, a
partner and portfolio manager at Austin, Texas-based Sage
Advisory Services, which oversees $8.5 billion.
“The dollar is the pressure valve” and the U.S. will
allow the currency to devalue to reduce its debt burden, he
said. “If I owe a trillion dollars, why not pay it back with 50
cents?”
‘Leverage Unwind’
Slower-than-average growth and reduced consumption will
keep prices under control, said John Hollyer, who helps manage
$29 billion of TIPS as a principal at Vanguard Group Inc. in
Valley Forge, Pennsylvania, which holds a smaller percentage of
the securities than is contained in benchmark indexes.
“This period of ease is likely to be very long relative to
other historic periods,” said Hollyer, who recommended TIPS in
October. “This is a multigenerational leverage unwind, and will
take a substantial time to work through.”
Consumer borrowing fell in December for an 11th straight
month, the longest on record, according to a Fed report released
on Feb. 5. The Labor Department said the same day the economy
lost almost a million more jobs in the 12 months ended in March
2009 than it had previously estimated.
“In December people were getting over-optimistic about the
economy, and January’s been wiping the slate clean,” said Brian
Weinstein, a managing director who oversees $9 billion in TIPS
at New York-based BlackRock.
China’s Engine
China, an engine of world growth, is trying to keep its
economy from overheating by limiting credit expansion to prevent
asset bubbles and restrain inflation. The nation’s central bank
said Feb. 12 it will raise the amount of money banks need to
keep in reserve for the second time in a month.
“Growth in the U.S., growth globally is going to be quite
modest in the next year or two,” said Wan-Chong Kung, who helps
oversee $89 billion as a money manager at FAF in Minneapolis,
the asset-management arm of U.S. Bancorp. “So with that,
inflation should be fairly well contained and well behaved.”
Yields on two-year Treasuries, which dropped to an eight-
week low of 0.72 percent on Feb. 5, show diminishing concerns
about inflation. Investors sought the safety of U.S. debt as
growing deficits threatened Europe’s economic stability. Lower
yields also suggest investors expect the Fed to keep interest
rates near record low levels.
Rising Dollar
The dollar approached a nine-month high versus the euro on
Feb. 12 after the European Union offered few details of an
agreement to help Greece weather its debt crisis.
“I see a return to disinflation or deflation,” said
Michael Cheah, who used to work at Singapore’s central bank and
now manages $2 billion in bonds at SunAmerica Asset Management
in Jersey City, New Jersey. “I don’t need any protection
against inflation.”
The shift in demand comes as the Treasury considers more
frequent auctions of TIPS to make them easier to trade. The U.S.
will sell 30-year TIPS on Feb. 22 for the first time since 2001.
Sales will likely total a record $80 billion to $85 billion this
year as the Treasury raises $2.5 trillion in the bond market,
according to London-based Barclays Plc, the biggest dealer of
the securities among the 18 that trade directly with the Fed.
“We expect TIPS to have negative returns this year,” said
Barclays strategist Michael Pond. “The market will need to
absorb a considerably greater amount of supply this year than
they did last year simply because the Fed won’t be around to
take down a significant portion of fixed-income supply.”
For Related News and Information:
Bond yield forecasts: BYFC <GO>
Top bond market news: TOP BON <GO>
Inflation-linked bonds: ILBE <GO>
Sovereign debt monitor: SOVR <GO>
Treasury auctions: AUCR <GO>
--With assistance from Rich Miller and Mike Dorning in
Washington. Editors: Dave Liedtka, Robert Burgess
To contact the reporters on this story:
Oliver Biggadike in New York at +1-212-617-7188 or
obiggadike@bloomberg.net;
Daniel Kruger in New York at +1-212-617-2986 or
dkruger1@bloomberg.net;
Keith Jenkins in London at +44-20-7330-7543 or
Kjenkins3@bloomberg.net.
To contact the editor responsible for this story:
David Liedtka at +1-212-617-8988 or
dliedtka@bloomberg.net.
Top headline on BB today.
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