For almost a year Wan-Chong Kung avoided U.S. government debt insured against inflation as consumer prices stagnated. Now, the bond-fund manager at Nuveen Asset Management whose inflation-indexed fund has beaten 95% of its peers the last three years, is loading up on Treasury Inflation-Protected Securities.
Her change comes as Federal Reserve Vice Chairman Janet Yellen, who voted for every stimulus measure since 2008, became the favorite to succeed Ben S. Bernanke as the next Fed chief and the central bank maintained its $85 billion a month in bond buying. Policy makers also said their target interest rate for overnight loans between banks may rise at a slower pace than suggested by historical measures.
That last “big dovish surprise” shows the Fed is “continuing to err on the side of promoting sustained job growth potentially at the risk of higher inflation,” Kung, who helps manage $125 billion at Nuveen, said in a Sept. 24 telephone interview from Minneapolis.
Kung has plenty of company. TIPS, as the inflation-indexed bonds are known, have gained 3.5% since Sept. 5, the best three-week rally since August 2011, after losing 8.7% in the first eight months, the most ever in that period, according t0 Bank of America Merrill Lynch's U.S. Inflation-Linked Treasury Index.
Now, fund companies from Nuveen to SEI Investments Co. say the Fed's continued stimulus will lift market expectations for faster increases in the consumer price index, leading to more gains for TIPS. Inflation-protected debt pays a lower coupon than non-indexed Treasuries. In exchange, investors receive an adjustment on the principal equal to the rise in the CPI.
Societe Generale SA recommends the debt even as economists at France's second-biggest lender forecast inflation will remain subdued. The bank's fixed-income strategists suggested buying TIPS after the Federal Open Market Committee Sept. 18 maintained the pace of bond buying and signaled that benchmark rates will remain low into 2016.
“The Fed was willing to lose a little bit of its credibility to be dovish,” Jorge Garayo, a fixed-income strategist at Societe Generale in London, said in a telephone interview on Sept. 23. It isn't clear if the Fed's reaction “to inflation will be different or not, but market participants believe it will,” he said.
Little Inflation
Treasuries that aren't indexed for inflation, which erodes the value of bonds by reducing the purchasing power of a security's fixed payments, have gained 1.9% since Sept. 5, Bank of America indexes show, indicating little concern that inflation will get out of control.
Even after the Fed purchased more than $3.1 trillion in government and mortgage bonds and held its benchmark lending rate at about zero since December 2008, signs of rising prices remain scarce. The Fed's preferred measure of inflation, the personal consumption expenditures deflator, rose 1.2% in August, down from a revised 1.3% increase the month before, the Bureau of Economic Analysis said Sept. 27. It has remained below policy makers' 2 percent target since April 2012.
The gauge fell at an annual rate of 0.1% in the second quarter, the Bureau of Economic Analysis said Sept. 26.
“As far as I can see, you don't have any inflationary pressure,” Dan Heckman, a fixed-income strategist at the U.S. Bank Wealth Management unit of U.S. Bancorp, which manages $110 billion, said in a Sept. 24 telephone interview.
Yields on 10-year TIPS fell 5 basis points last week, or 0.05 percentage point, to 0.45%, according to Bloomberg Bond Trader prices. Non-indexed Treasury yields of similar maturity declined 11 basis points to 2.63 percent.
The 2.18 percentage-point gap in yields, which has expanded from this month's low of 2.07 percentage points on Sept. 9, is known as the break-even rate and reflects investors' expectations for inflation over the life of the securities.
The price of the benchmark 10-year TIPS note, a 0.375 percent security due in July 2023, rose 14/32, or $4.38 per $1,000 face amount, to 99 9/32. The 2.5% Treasury maturing in August 2013 increased 30/32, or $9.38 per $1,000 face amount, to 98 29/32, Bloomberg Bond Trader prices show.
Yields fell to 0.43% on the TIPS and to 2.60% on the non-indexed notes today as of 7:41 a.m. in New York.
Both types of bonds have benefited this month from signs of a slowing U.S. economy that prompted the Fed to maintain its program of buying of $45 billion a month of Treasuries and $40 billion of mortgage bonds.
Economic growth is also threatened with Congress locked in a budget stalemate that raises the risk of the first government shutdown in 17 years. The Senate is schedule to reconvene later today, when it is forecast to reject a House plan seeking to delay and limit President Barack Obama's Affordable Care Act.
(Bloomberg News)
