Rising Inflation Expectations

I’ve written in the past about the misinterpretation of yield numbers on TIPS (Treasury Inflation Protected Securities).  While the yield numbers (and price when expressed as percentage of par unadjusted for the inflation index ratio) have given false readings, the dollar value of a basket of TIPS does offer insight.   Consider the chart below: 

TIPS i-share vs 10-year Treasury Futures (June 09 contract)

TIPS iShare vs 10-year Treasury Futures (June 09 contract)

The chart illustrates the relative price performance of the Barclay’s iShare TIPS fund (NYSE Arca: TIP) and the 10-year T-note futures (June 09 contract) over the last 4 months.  As can be seen from the chart, the basket of TIPS in the iShare has appreciated by about 8% while the treasury contract has been roughly flat.  The best explanation for this relative outperformance is rising inflationary expectations. 

Last fall, when TIPS falsely appeared to be signaling deflation, those who championed massive government spending cited TIPS performance as supportive evidence.  Now that TIPS are clearly starting to warn of rising inflation, those same voices are noticeably silent on this fact. 

Disclosure: neither the author nor his clients have direct ownership in the TIPS iShare or T-note futures.

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2 Responses to “Rising Inflation Expectations”

  1. Daniel Says:

    Wow, TIPS forecast 1.3% annualized CPI over the next 10 years! HUUUUUUUUGE inflation! “Now that TIPS are clearly starting to warn of rising inflation” you have got to be kidding me!

  2. Jeff Korzenik Says:

    A few points:
    1) The past writing I’ve done on TIPS illustrates that simply subtracting TIPS yield from conventional Treasury yields is not a viable measure of what the TIPS are forecasting, particularly given the volatility of the commodity markets.
    2) Even if one were to assume that the simplistic TIPS analysis is correct, a swing in expectations from deflation to inflation is a big deal, particularly from the standpoint of public policy response
    3) Either way, the point was not the magnitude of anticipated inflation, but the direction of the expectation — rising inflationary expectations, no matter the magnitude, have very distinct investment implications
    4) The other point is to highlight that much of the argument for massive government spending has been based on combating deflations – several of the proponents of this view (e.g., Roubini) held out TIPS yields as evidence of deflationary expectations. These arguments need to be revisitied in light of mounting evidence that those expectations no longer exist, and arguably never did.

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