Even after their recent rally, TIPS prices are still at a relatively low level, BlackRock's Jeffrey Rosenberg tells Bloomberg. "Over the long run, we think there's room for further inflation expectations to build into the market."
SocGen suspects investors have not forgotten about a powerful bond rally in each January of the past three years, each with its own rationale ("the 2H13 taper tantrum was reversed as the economy started to run out of steam; early 2015 saw the front running of the ECB’s QE; early 2016 saw a panic reaction to large capital outflows in China").
Still, firm says it does not expect a repeat:
The macro environment differs sharply. Global growth peaked in autumn 2013, and from there slowed down consistently into mid-2016. But it has now turned. Global inflation has also picked up, with U.S. wages, oil prices and the Chinese PPI all pointing north. Economic momentum into the turn of the year, especially in the DM world, is such that the global economy is likely to prove more resilient to shocks.
"The cyclical improvement, along with the ongoing reflation effort (U.S. fiscal stimulus in the pipe, ECB, BoE and BoJ remain very accommodative) will push market participants to reduce unprecedented exposure to the interest rate risk.
While the yield on the 10-year Treasury note has gained 22 basis points to 2.08% since the election, the yield on the same-maturity inflation-linked Treasury is up just five basis points. That's a pretty sizable relative move, says Standish Mellon's Raman Srivastava.
The conventional thinking here is that the new president's policies such as lower taxes, lower regulation, and more infrastructure spending are going to lead to higher inflation.
Speaking to CNBC this morning, fund manager Stanley Druckenmiller - who had been pessimistic about the U.S. economy, said that he is now "quite, quite optimistic" on the U.S. economy following the election of President-elect Donald Trump. "It's as hopeful as I've been in a long time."
"I sold all my gold on the night of the election." Why? “All the reasons I owned it for the last couple of years seem to be ending", namely, expectations that inflation is now set to spike, forcing money out of safe assets - like gold and Treasurys - and into the dollar.
Druckenmiller said he now has a “large bet on economic growth. I’m short bonds, Bunds, Italian bonds, U.S. bonds.” The trades reflect his expectation of higher deficits and stronger growth leading to another surge in debt.
Druck said he is “hopeful” on the Trump administration and political climate. “I would not be surprised if we’re looking at the absolute peak of divisiveness.”
Inflation-protected securities are a natural haven when investors start to worry about rising inflation, but maybe it's the election. Bloomberg today runs a story about a "freaked out" 35-year-old tech worker in San Francisco who sold his entire portfolio of stocks and put the money in TIPS thanks to his worry that Trump might win the election. Takes all kinds.
Tracking the differential in the yield of TIPS (Treasury Inflation-Protected Securities) and conventional Treasury notes renders an indicator known as the BEI - the breakeven inflation rate.
The BEI gets its name because it represents a point of indifference - the level of inflation at which you’d receive approximately the same total return on your TIPS as you would on a conventional T-note if CPI inflation averages that rate over the next 10 years.
Back in February, the 10-year BEI cratered at 1.18%. It's now retesting the 1.67% resistance area. If it break, and stays, above 1.70%, the next upside objective is the 1.90% level, SA author Brad Zigler says.
If the pattern holds, investors could readjust their portfolio’s fixed income exposure and duration with the following ETF play: The 10-year BEI is proxied by the price ratio of the iShares TIPS Bond ETF (NYSEARCA:TIP) versus the iShares 7-10 Year Treasury Bond ETF (NYSEARCA:IEF).
Zigler notes that the TIP/IEF ratio broke above its 100-week simple moving average ("SMA" - see chart here). "Without going into a bunch of technical interpretation, suffice it to say that this sets up TIPS as the better buy for income-focused investors - for the long term."
It's not just about higher energy prices, he says, The rising dollar has been a headwind to inflation, and that's beginning to abate. He also notes prices of more stable service-based components of the CPI have begun rising, as are wages, and consumer inflation expectations.
TIPS are pricing in inflation of just 1.4% over the next ten-years, and prices have slipped in the past few days as investor ratchet up rate-hike expectations.
That's a mistake, says Turnhill, who expects the Fed to remain pretty cautious on tighter policy. "Rising inflation means owning TIPS in lieu of nominal Treasurys can be an important hedge for fixed income portfolios."
"A Fed less concerned about [inflation] shifts risk to a price breakout," says FTN Financial's Jim Vogel, quickly summing up the bull case on TIPS.
Yellen's dovish remarks yesterday - especially in the face of core CPI up 2.3% Y/Y in February - sent the five-yield TIPS yield lower by 15 basis points. It's off another four bps today to negative 0.33%. TIPS have returned more than 4% YTD, outperforming most vanilla Treasurys, according to Barclays.
Pimco and BlackRock are among those bullish on the paper, and TIPS ETFs have raked in a record $2.14B this quarter.
With many investors stuck in the recent past's worry over deflation,TIPS "reflect insufficient risk premium" that inflation could run higher than the Fed's 2% target, says Pimco's Mihir Worah, CIO real return and asset allocation.
"These U.S. government-backed bonds, and inflation-linked bonds of several other nations, can be the cornerstone of a portfolio of inflation-hedging assets, depending on the specific objectives of each investor."
The $13.8B iShares TIPS Bond ETF (NYSEARCA:TIP) saw $634M of inflows last week, the highest weekly amount since the fund's opening in 2003. The move came alongside the latest CPI report which showed core prices rising faster than expected for a 2nd straight month, as well as the continued bounce in crude - now up about 30% from its March low.
At the Barron's roundtable in January, Bill Gross singled out the Schwab U.S. TIPS ETF (NYSEARCA:SCHP) for gains, expecting a rebound in returns with just a modest reversal in the oil bear market.
Oil price drops similar or greater in magnitude than what's recently been seen have occurred a number of times over the past 30 years, say new Pimco CIO Daniel Ivascyn along with Saumil Parikh. Some have coincided with major recessions and others with faster global growth. So what gives for 2015?
The short answer: This drop in oil is supply-, not demand-driven, they conclude, and thus should foster faster economic growth than otherwise next year.
As for inflation, expect negative headline prints in developed economies next year, but these should bounce back later in 2015 and into the following year.
Investment themes: 1) The outlook for easier monetary policy (in all but the U.S.) has been priced in, making for limited upside for high-quality duration 2) TIPS are attractive as their prices have more than discounted the coming negative inflation prints 3) Globally, eurozone peripheral bonds are the pick 4) In the U.S. non-agency mortgages (see Ivascyn's PDI) are poised for outperformance, but agency paper is overvalued, particularly as the Fed's purchases have ended.
Ivascyn also manages the Pimco Income Fund (MUTF:PONAX) and (formerly managed by Bill Gross) the Pimco Unconstrained Bond Fund (MUTF:PUBAX).
Expectations of U.S. and euro zone break-even rates seem to be heading in opposite directions, as investors wager on opposing consumer price outlooks. The break-even rates, as measured by the difference between yields on 10-year nominal Treasury notes and TIPs, are at about 2.3% in the U.S. This greatly differs in the euro zone, where Germany reports a rate of 1.3%.
TIPs are expected to gain in popularity over the next year, as break-evens expect to rise in par with U.S. inflation. However, the euro zone is currently dealing with a falling inflation rate. Despite the European Central Bank instituting a 2% inflation mandate, annual inflation in the euro zone was only 0.5% in May.
After pouring money into U.S. Treasury ETFs in the first two months of the year, investors pulled $10.3B in March, the largest amount withdrawn since December 2010, according to Bloomberg. The $7.86B iShares 1-3 Year Treasury Bond ETF (SHY) is the leader on a percentage basis - losing one-third of its AUM this month.
The catalyst is clearly the FOMC's signal on rate hikes beginning in about a year. “When the market thinks the Fed is going to raise rates, they don’t tend to stick around in short-dated bonds,” says global macro strategist Thomas Higgins.
"Investing in fixed income today is almost the opposite of what it was one year ago," says BlackRock's Rick Rieder, believing those sectors which performed poorly last year will do well in 2014. As such, he sees the best value in long-dated munis and long-dated TIPs, and wants to avoid the belly of the curve - 3 to 7 years.
He gives Janet Yellen good grades for her performance yesterday, saying she's merely acting appropriately to changing economic conditions. The "dots" are "a survey, not policy," says Rieder, but nevertheless, the markets quickly priced to them.
The SPDR Barclays 0-5 Year TIPS ETF (SIPE) launches today and will offer investors short term exposure to the TIPS market; this space features a lot of competition.
The iShares Enhanced International Large Cap ETF (IEIL) and Enhanced International Small Cap ETF (IEIS) began their active strategy this morning and offer expense ratios of 0.35% and 0.49% respectively.
The PowerShares International BuyBack Achievers Portfolio (IPKW), like IEIL and IEIS, is based on a previously launched domestic strategy; the PowerShares BuyBack Achievers Portfolio (PKW).
"The Committee sees the improvement in economic activity and labor market conditions ... as consistent with growing underlying strength in the broader economy," the FOMC says, adding that the decision to scale back QE by $10B per month is based on "the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions."
Although the Committee says it will "likely reduce the pace of asset purchases in further measured steps [should] incoming information support [the] ongoing improvement in labor market conditions and inflation moving back toward [the] longer-run objective," the Fed notes that asset purchases are "not on a set course."
FOMC also says it "anticipates .. that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%."
Updated FOMC projections: 2014 PCE inflation now seen at 1.4-1.6% (from 1.3-1.8% in September); 2014 GDP now seen at 2.8-3.2% (from 2.9-3.1% in September); 2014 unemployment rate now seen at 6.3-6.6% (from 6.4-6.8% in September). Full release
10-year yield is at 2.91% versus 2.87% just prior to the announcement.
Dow (DIA +0.9%), S&P (SPY +0.6%), and Nasdaq (QQQ) all staged brief rallies on the news but have since retraced a bit. Gold (GLD +0.3%) fell sharply initially but recovered.