Wednesday, March 2, 2016

"The Treasury Market Raises Its Inflation Outlook" (buy TIPS)

As well it should.
From Capital Spectator:
The US Treasury market’s implied inflation forecast has surged in recent days, albeit after reaching unusually low levels last month. Nonetheless, the rollercoaster of revising expectations rolls on, and this time there’s an upside bias bubbling. The spread between the nominal 10-year yield and its inflation-indexed counterpart reached 1.48% yesterday (Mar. 1), based on daily data from That’s still a low rate relative to the roughly 1.5%-2.5% range in recent years. But the latest pop marks a sharp increase from mid-February, when the market’s inflation forecast at one point dipped to 1.18%.

The upward bias of late looks reasonable in the wake of last week’s January report on personal income and spending, which revealed a firmer inflation trend. The personal consumption expenditures (PCE) price index increased 1.3% for the year through January, the strongest annual gain since Oct. 2014. Meanwhile, the Fed’s preferred inflation benchmark—core PCE, which excludes food and energy—ticked up to a 1.7% year-over-year increase, which marks the biggest advance since July 2014.
The upward repricing of inflation expectations can be seen as a correction after weeks of anticipating weaker economic growth via bearish signals pouring forth from the equity and bond markets. But the January macro profile suggests that the US macro trend is stronger than the previously assumed. Slow growth continues to be the working assumption for the near-term future, but the case is still unconvincing for arguing that a new recession has started, or is about to start. Indeed, the Atlanta Fed’s GDPNow model is currently projecting a 1.9% gain (seasonally adjusted annual rate) for US output in this year’s first quarter (as of Mar. 1). That’s a modest increase, but it’s conspicuously above the 1.0% GDP rise for last year’s fourth quarter. 
Perhaps, then, it’s no surprise that the market is again repricing yields to reflect expectations for a modest growth trend. The 2-year Treasury yield, which is considered the most sensitive to rate expectations, has rebounded to 0.85% as of yesterday (Mar. 1)—the highest since late-January....MORE
Amey Stone at Barron's Income Investing has been on a Buy TIPS kick for the last month.
First off it was Feb. 6's "TIPS: Cheap and Contrarian" which came out before the consumer inflation uptick came out on the 19th:
With inflation expectations moribund, buying a hedge against markets getting it wrong may be worthwhile. But it can be a complicated strategy....
She followed up on the 25th with "Goldman Disagrees With What TIPS Are Saying About Inflation":
Economists at Goldman Sachs pointed out in a research note Tuesday that inflation rates forecast by Treasury Inflation-Protected Securities (TIPS) don’t make a heck of a lot of sense. Even as the core Consumer Price Index has risen lately, TIPS breakevens are at all-time lows — just 1.37%.
The securities have priced in average inflation of just 1.5% for the next 10 years. Goldman’sElad Pashtan writes in the report:
Following today’s market close, the 10-year breakeven traded at 1.37%, implying that headline CPI will, on average, be 88bps below the Fed’s inflation target in CPI terms over the next ten years (the gap between headline CPI and headline PCE has averaged roughly 25bps). Forward breakeven rates paint a similarly stark picture: headline CPI is not priced to average more than 1.5% during any one-year period over the next ten years.
Goldman thinks inflation will run higher than that. Pashtan writes:
Looking ahead, we expect headline CPI to average 1.3% in 2016, and to accelerate to 2.4% in 2017. Both levels are well above forward rates implied by TIPS. Despite our inherent disagreement with inflation markets on breakeven levels, we—along with other economists responding to the Philadelphia Fed’s Survey of Professional Forecasters—do agree with TIPS and assign a very low probability for outright deflation in the coming year.
Why are TIPS breakevens so low if prominent economists disagree? Pashtan sees three possible explanations:...MORE
Feb. 24
The Velocity of M1 Money Stock May Have Stopped Declining
Feb. 19
A Look At The Consumer Inflation Numbers
Feb. 8
You Want Inflation, "Why doesn’t the ECB just buy oil?"