Comment In the first block above we talk about the huge growth of long-only commodity funds. Why now? We have argued trying to bet on inflation via stocks and TIPS has led to frustration and poor performance. So, investors have done the rational thing and been seeking out direct bets in commodities rather than the more traditional proxies. The stories below suggest others are coming around to this line of thinking.
Is too much “monkeying around” with the CPI index partially to blame for the boom in long-only funds? We believe so.
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Bloomberg.com – TIPS Flunk Inflation Test as Gasoline, Groceries Overtake CPI
Treasury Inflation Protected Securities aren’t living up to their name for bond investors who say they can’t trust the way the U.S. government calculates the rising cost of consumer goods. Morgan Stanley, the second-biggest securities firm, and FTN Financial, a unit of Tennessee’s largest bank, are telling clients to pare holdings of TIPS, whose principal amount rises with the Labor Department’s consumer price index. Morgan Stanley says derivatives tied to inflation expectations are a better bet, while FTN recommends corporate and agency bonds because the index doesn’t reflect the actual rate of U.S. inflation.
Comment To be specific, what are the problems with TIPS that are leading to a loss in investor confidence in them?
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You are short a call on government honesty. They’re a government liability linked to a number only the government produces and only the government believes;
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You are taxed on their phantom income, so you are short a call on future government tax policy. Who can’t predict what tax rates are going to be?
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Their implied breakeven is distorted by flights to quality in the nominal Treasury market.
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If the market is operating efficiently, the seller of TIPS should price their inflation insurance at such a level that only unexpected increases in the CPI-U will provide a gain to the buyers of TIPS…if the government chooses to report them honestly; and
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It is too easy to demonstrate the variables tossed about blithely as affecting the TIPS market do nothing of the sort.
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Bloomberg.com – Michael R. Sesit: Inflation Blame, Mideast Money, U.S. Bank Regulation: Timshel
In a case of the pot calling the kettle black, the U.S. Federal Reserve, the European Central Bank and the Bank of England are telling their developing-country counterparts to get their respective economic houses in order and do something about growing inflationary pressures. “In those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability,” Fed Vice Chairman Donald Kohn said last week. China is growing at an annualized 10.6 percent; India is chugging along at 8.8 percent; and Taiwan’s gross domestic product is expanding 6.1 percent, while the economies of Thailand, Malaysia, Singapore and Hong Kong are advancing between 6 percent and 7.1 percent a year. No doubt, this fast growth is contributing to global inflation. Food and energy prices, which account for a much bigger share of developing-country consumer spending than in industrialized nations, are soaring. Crude oil for future delivery climbed to a record $1.4585 on July 3, while corn futures reached a record $7.99 a bushel on June 27. -
The Wall Street Journal – Treasury Auction to Test Market’s Fear of Inflation
Surging oil prices have spurred global investors to hedge inflation risks, and inflation-protected government debt — known as linkers — has been in vogue. The market’s appetite will be tested Thursday, with the Treasury Department set to sell 10-year Treasury Inflation-Protected Securities, or TIPS, as U.S. linkers are known. Some investors have found a new trade: playing off changing inflation expectations in the U.S. against those in the euro zone. Specifically, they say, inflation expectations in the U.S. are about to catch up with the higher expectations in Europe. With investors more worried about euro-zone inflation, the spread between the so-called break-even rates — the yield spread between linkers and nominal bonds of similar maturity — in the U.S. and in Europe has widened. Investors bet this isn’t sustainable, and the gap should narrow in the months ahead as U.S. inflation expectations rise. -
The Wall Street Journal – Editorial: Who Let the Bears Out?
The stock market had been a contrary indicator all along despite many prognosticators calling for an economic recession. But the market has now thrown in the towel in recent days and entered bear territory (even though corporate profits remain strong). What gives? Nervous stock investors are focused on Washington. In the shrewd summary of TrendMacro’s Donald Luskin, they are “increasingly alarmed by the Fed’s failure to reassure markets that it intends to support the dollar and, implicitly, stabilize the oil price.”