TIPs Say We're Heading Towards Deflation

The TIPs say deflation is coming and may stay around for a bit:

Yet, if you believe the yields on US Treasury inflation protected bonds, or Tips, we shall have a 2.2 per cent fall in prices in 2009, a 2.5 per cent decline in 2010 and only flat prices in 2011. If that turns out to be true, the real interest rate burden on even the highest-rated borrowers will be extremely hard to bear.

As a practical matter, long before we had significant "negative prints" of consumer prices, the Federal Reserve would just flat out buy Treasury bonds and monetise away with "quantitative easing". Gold dealers would replace hedge fund managers at the art auctions, model agency parties and Congressional hearings.

But there's more to the story. John Dizard says that the market is simply becoming less efficient:

What's really going on is another effect of the disappearance of dealer and arbitrageur capital. The dealers can't afford to make efficient markets, given their decapitalisation, downsizing, and outright disappearance. That means anomalies sit there for weeks and months, where they would have disappeared in minutes or seconds.

Here's another look at yield you can get for the TIP maturing in two months.

It's currently yielding 13.73%.

Here's a look at the current TIPs yields-to-maturity listed by maturity date.

Comments

[Fubba:]

Huh? I can't tell from this analysis whether TIPS or TIP funds are a buy here or not. What's with the 13% yield on two month TIPS? Why won't the printing of trillions of $'s for all of the bailout programs lead to inflation, not deflation? Help!

2008 Nov 20 08:36 AM

[ur2smrt4me:]

you can't tell because there is no way of knowing - I believe the author is saying if you trust the yield curve then we're in for serious deflation, but it's hard to trust the yield curve in an inefficient market

p.s. I am long IPE


On Nov 20 08:36 AM Fubba wrote:

> Huh? I can't tell from this analysis whether TIPS or TIP funds are
> a buy here or not. What's with the 13% yield on two month TIPS?
> Why won't the printing of trillions of $'s for all of the bailout
> programs lead to inflation, not deflation? Help!

2008 Nov 20 11:38 AM

[bigmoney:]

I have a bunch of these TIP bonds in a 401k. I don't really understand bonds very well, but I did see that my fund sagged significantly. With yields rising, I suppose that means money is flowing out of TIPS.

2008 Nov 20 06:35 PM

[_richard_:]

The spike for Jan09 seems to be for the return being annualized for a <1 year maturity. Adjust for that and the curve looks reasonable.

FWIW, I suspect rampant deflation to be unlikely. Baked into the TIPS current pricing is that there will be substantial deflation and/or that TIPS are just less liquid than the big market in Treasuries. I just picked up a basket of TIPS that mature in April of 2010 with a (presumptive) yield of nearly 7%. With Bernanke at the Fed, I imagine that any sustained deflation will be fought with running the printing presses in overtime. Half a percent deflation for part of a year I'd believe; sustained deflation without the Fed substantially increasing the monetary and forcing inflation I find implausible.

2008 Nov 28 03:05 PM