Inflation Bonds Show Growth Bigger Worry as Rates Point to 1.3% Global CPI
Returns on inflation-linked bonds fell below those of government debt by the most in almost three years as the world economic slump makes it less likely that easy monetary policies will trigger spiraling consumer prices.
Global sovereign debt gains are 1.3 percentage points higher since the end of July than on so-called linkers according to Bank of America Corp. indexes. The difference is the most since November 2008. The gap in yields for these bonds on Sept. 9 indicated investors anticipated an annual global inflation rate of 1.35 percent, down from 1.86 percent four months earlier.
From Australia to the U.K. to the U.S. central bankers are cutting inflation estimates, giving officials scope to try to boost growth rates and employment. President Barack Obama presented a $447 billion package of tax cuts and spending to a joint session of Congress last week. The European Central Bank left interest rates unchanged Sept. 8, saying economic prospects had worsened.
“The inflation-linked debt market is confirming signals from pretty much all other capital markets about concerns over the outlook for European and U.S. economic growth,” Jack Malvey, chief global markets strategist at Bank of New York Mellon Corp., which manages $1.3 trillion, said in an interview on Sept. 8. “The concerns which the market generally shared over the first half of 2011 about the potential resurrection of inflation in so-called advanced economies have subsided.”
Since the Federal Reserve’s $600 billion of quantitative easing bond purchases ended June 30, expected rates of inflation have declined in the U.S., Germany, Australia, Sweden and Japan, according to data compiled by Bloomberg.
The International Monetary Fund last week cut its forecast for world growth to 4 percent in 2011 and 4.2 percent in 2012 from 4.2 percent and 4.3 in August, according to the Ansa news agency citing a draft of the fund’s World Economic Outlook set to be released Sept. 20.
The so-called 10-year break-even rate between yields on U.S. government notes that aren’t indexed to consumer prices and Treasury Inflation Protected Securities, or TIPS, was 0.69 percentage point below the peak reached eight months after Fed Chairman Ben S. Bernanke’s signal in August last year that the central bank might begin another round of debt purchases to avert deflation and boost growth.
That gap, which shows investors’ inflation expectations over the life of the securities, has fallen to 1.97 percent as of 10:25 a.m. in New York from 2.67 percent in April, and up from 1.47 percent in August 2010.
Australian bonds show a similar picture. Consumer prices in Australia will rise at a 2.55 percent annual pace over the next five years, about one basis point above the lowest level since September 2010, yields on inflation-linked debt show.
Treasury 10-year note yields fell to an all-time low of 1.877 percent today, and U.S. government securities returned 2.8 percent in August, the most since the depths of the financial crisis in December 2008. They’ve gained 7.1 percent this year according to a Bank of America Merrill Lynch index.
Indexes compiled by Bank of America show diminishing concerns about inflation worldwide. The difference in yields between the firm’s Global Sovereign Bond Master index and its Global Government Inflation-Linked index has narrowed to 1.35 percentage points on Sept. 9 from 1.57 percentage points at the end of June and 1.86 percentage points April 8, the 2011 high.
The gauges differ as many countries in the Global Sovereign index, such as Malaysia, don’t have inflation-linked debt.
Inflation to Fall
Global sovereign debt had a 1.3 percentage point lower return in July than inflation-linked securities, and 3.3 percentage points less in gains for the first half of the year, according to Bank of America.
The IMF forecast in June that developed nation inflation would rise to 2.6 percent this year from 1.6 percent in 2010, and fall to 1.7 percent in 2012.
In Brazil, inflation linked bonds advanced 7 percent since July 8, compared with a 5.8 percent increase in notes with fixed coupons. The country lowered borrowing costs Aug. 31, even as consumer prices increased to a six-year high of 7.2 percent in August. The central bank aims to keep inflation between 2.5 percent and 6.5 percent.
“Containing inflation pressure in Brazil is a very hard job,” said Marcelo Schmitt, a fund manager in Sao Paulo at SulAmerica Investimentos, which manages 20 billion reais ($12 billion). “The economic policy mix is stimulative. This is something that is not sustainable in the medium to long term.” He’s buying inflation-linked bonds in Brazil.
Employment in the U.S. unexpectedly stagnated in August, increasing pressure on Obama to spur an economy that’s barely growing two years into the recovery. The U.S. economy expanded at a 1 percent pace in the second quarter following a 0.4 percent gain in the first three months of the year, the Commerce Department reported last month.
Obama urged the U.S. Congress Sept. 8 to pass a $447 billion jobs plan that sought to boost spending on infrastructure, stem teacher layoffs, and cut in half the payroll taxes paid by workers and small business owners.
A measure of traders’ inflation expectations that the Fed uses to help determine monetary policy plunged to 2.61 percent from 3.23 percent at the start of last month. The five-year, five-year forward break-even rate, which projects what the pace of annualized price increases for the five-year period starting in 2016 will be, peaked this year just below the 3.28 percent high reached in December 2010, touched amid the Fed’s second round of quantitative easing.
The Fed’s informal target range for longer-term core inflation is 1.7 percent to 2 percent as measured by a Commerce Department gauge tied to consumer spending.
“The bond markets’ focus has shifted from concerns about inflation to concerns about economic growth,” Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh, said in an interview Sept. 6.
The euro zone sovereign-debt crisis has sapped business and household confidence. The European Commission’s index of executive and consumer sentiment fell last month to 98.3 from 103, its biggest drop since December 2008, three months after the collapse of Lehman Brothers Holdings Inc.
The economy faces “particularly high uncertainty and intensified downside risks,” ECB President Jean-Claude Trichet said at a press conference in Frankfurt on Sept. 8 after the bank left its benchmark rate at 1.5 percent. The ECB cut its 2011 growth forecast to 1.6 percent from 1.9 and to 1.3 percent from 1.7 percent for 2012. Inflation forecasts were left unchanged at 2.6 percent for 2011 and 1.7 percent for next year. Growth in the 17-nation euro area slowed to 0.2 percent in the second quarter from 0.8 percent in the first.
The 10-year German breakeven rate narrowed to 1.43 percentage points Sept. 9, the lowest since August 2010, while the French equivalent shrank to 1.99 percent, also the lowest since then.
As the British economy has faltered, the 10-year U.K. breakeven rate has fallen to 2.67 percentage points from 3.10 two months ago. The Bank of England kept its key rate at a record low of 0.5 percent and left its bond-purchase program at 200 billion pounds ($320 billion) on Sept. 8.
A gauge of U.K. services activity dropped the most in a decade last month, a survey showed, days after reports showed manufacturing shrank and construction growth slowed.
Fed Has ‘Tools’
“The Fed is limited in what they can do to get the economy going and booming again, however they do have the necessary tools to make sure inflation doesn’t become too low,” said James Barnes, a money manager in Wyomissing, Pennsylvania at National Penn Investors Trust, which oversees $1 billion in fixed-income assets.
Fed officials last month discussed a range of tools, including buying more government bonds and lengthening the average maturity in its portfolio, without coming to an agreement on what they might do should the economy weaken further. Policy makers will debate their options this month at a two-day meeting that was originally scheduled to last one day.
“What the market is saying is we don’t have enough growth globally: do something about it,” said Krishna Memani, director of fixed income at OppenheimerFunds Inc. in New York, who helps manage $70 billion, in an interview. “Whether it comes from monetary policy, fiscal policy, the markets are ambivalent. The inflationistas have been dead wrong.”
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