Treasury Inflation Notes Outperform as U.S. Auctions $13 Billion

U.S. inflation-indexed bonds are outperforming Treasuries as investors seek a hedge against the risk of higher consumer prices.

Today’s $13 billion auction of 10-year Treasury Inflation Protected Securities attracted the highest demand in two years, including record purchases from a category of bidders that includes foreign central banks. The surge in demand pushed the gap between yields on fixed-rate Treasuries up the most in a month. The notes were sold at a yield of 0.339 percent.

“It speaks to the slowly more pervasive view that inflation might be turning the corner,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 22 primary dealers that are obligated to bid at U.S. auctions. “The strength was surprising given how low real yields are.”

The gap between yields on 10-year notes and same-maturity TIPS, a gauge of trader expectations for consumer prices over the life of the debt known as the break-even rate, jumped to 2.22 percentage points, from as low as 2.17. The five basis-point increase was the biggest since April 17. The average rate for the past decade is 2.21 percentage points.

Conventional U.S. 10-year note yields rose two basis points, or 0.02 percentage point, to 2.55 percent at 5 p.m. New York time, based on Bloomberg Bond Trader data. Earlier they increased to 2.57 percent, the highest since May 14.

“Break-evens were cheap going into the auction, and that is why the auction went so well,” said Michael Pond, the New York-based head of global inflation-linked research at the primary dealer Barclays Plc. “Given the realized inflation backdrop, break-evens offer value as realized inflation continues to tick up.”

Investor Demand

Exchange-traded funds tracking U.S. inflation have seen inflows of $129 million this month, the first increase since March, according to data compiled by Bloomberg. Investors pulled out $448 billion in April, the data showed.

TIPS have returned 5 percent in 2014, versus 3 percent for conventional securities, according to Bank of America Merrill Lynch indexes. The securities lost 9.4 percent last year as the broad Treasuries market declined 3.4 percent amid a rally in higher-risk assets. It was the inflation-linked securities’ second annual loss since being introduced in 1997 and their worst, according to Bank of America Merrill Lynch’s U.S. Inflation-Linked Treasury Index.

Investors submitted bids for 2.91 times the amount of debt offered today, the most since the sale in May 2012. The average for the past 10 sales is 2.51.

Bidder Participation

Indirect bidders, the category of investors that includes foreign central banks, bought a record 66.3 percent of the securities. Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 6.3 percent of the TIPS.

The U.S. consumer price index rose 2 percent in April from a year earlier, the most since July, a Labor Department report showed on May 15. It was up 1.5 percent the prior month.

The Fed’s target for annual inflation is 2 percent. Its preferred gauge, a personal consumption expenditures index, has remained below the goal for almost two years. The measure increased 1.1 percent in March, the latest figure available, from a year earlier.

The central bank is scaling back the bond-buying program it has used to pump money into the economy amid signs growth is accelerating. It has expanded its balance sheet to more than $4.3 trillion since 2008 in bond purchases designed to lower longer-term borrowing costs, fueling concern the strategy would spur inflation. The Fed also has held the benchmark interest rate at virtually zero since 2008.

Fed Meeting

Policy makers are watching progress toward their goal of full employment as they consider the timing of the first interest-rate increase since 2006.

Minutes released yesterday of the Fed’s April meeting showed officials said continued stimulus to push unemployment lower doesn’t risk sparking an undesirable jump in the inflation rate.

Commodities have gained this year, with Standard & Poor’s GSCI (SPGSCI) Index of raw materials advancing 4.1 percent through yesterday, as the S&P 500 Index of stocks rose 2.2 percent.

Treasuries fell today as the National Association of Realtors reported that closings on previously owned U.S. homes increased 1.3 percent to a 4.65 million annual rate. Economists surveyed by Bloomberg projected a 4.69 million pace. The number of homes for sale jumped 16.8 percent in April.

The amount of Treasuries traded through Icap Plc, the largest inter-dealer broker of U.S. government debt, decreased for the first time in four days, falling 11 percent to $302 billion. The daily average this year is $340 billion, and the high was $606 billion on May 2.

To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Greg Storey

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