Wagers on U.S. Inflation Evaporate as April ETFs Pull BetCordell Eddings
Investors are having second thoughts over whether the Federal Reserve’s attempt to lift inflation will prove to be successful.
Exchange-traded funds tracking U.S. inflation saw the biggest withdrawals yesterday since June. Traders pulled $134 million alone from the iShares TIPS ETF, the largest fund tracking Treasury Inflation Protected Securities, erasing 60 percent of the inflation bets accumulated in March, according to data compiled by Bloomberg. The fund saw inflows of $326.8 million in March.
Demand for inflation protection has declined since Fed Chair Janet Yellen said on March 31 that slack in labor markets showed that the central bank’s accommodative policies will be needed for some time. The comments came less than two weeks after Yellen roiled markets by suggesting interest rates will rise by the middle of next year, indicating to some investors that consumer demand in the world’s largest economy will be strong enough to push inflation toward the Fed’s elusive 2 percent target.
“The Fed’s more hawkish tone has left the TIPS market rudderless and created a lot of confusion,” said Aaron Kohli, an interest-rate strategist at BNP Paribas SA in New York, one of 22 primary dealers that trade with the central bank. “From the start of easing the Fed said they would support inflation, but inflation hasn’t been anything but soft, and it begs the question whether the Fed is willing, or even capable, of boosting inflation ultimately.”
The outflows are dampening inflation optimism from March, when for the first time in 19 months, investors stepped up their buying of exchange-traded funds that hold Treasuries tied to cost-of-living increases, data compiled by Bloomberg show.
Since then inflation expectations have backtracked. A gauge for inflation, the gap between 5-year Treasuries and similar-maturity TIPS, known as the break-even rate, fell to 1.86 percent today. That’s close to the lowest level since the start of the year, after surpassing 2 percent last month to reach the highest level since May.
Bond-market expectations for consumer prices in the latter half of the coming decade, another measure used by the Fed called the five-year, five-year forward break-even rate, have declined to 2.38 percent, after falling to 2.37 percent on March 21, the lowest since June.
The Fed’s preferred gauge of inflation, known as the personal consumption expenditures deflator, has been below the central bank’s 2 percent goal for 22 straight months and rose just 0.9 percent in February from a year earlier. In the past year, the index has fallen below 1 percent four times and has never exceeded 1.5 percent. The last time inflation based on the Fed’s measure was so low during an expansion was in 1998.
“We could see additional outflows this year as there simply is no demand for TIPS at this point in time,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York. “The Fed is betting that the weakness we’ve seen early in the year will be transitory and that growth is poised to accelerate. With growth comes inflation, but the market needs to be convinced.”
Inflation expectations may rise after the government report April 4 that’s forecast show the economy added 200,000 nonfarm jobs in March, the most in four months, according to Michael Pond, the New York-based head of global inflation-linked research at primary dealer Barclays Plc.
“We believe a likely catalyst for a move up in break-evens will be the wage inflation data within the payroll report,” Pond wrote in a note to clients. “Without supporting evidence for higher realized inflation, break-evens are unlikely to move higher, in our view.”
Unlike Treasuries, whose fixed payments lose value as living costs increase, TIPS appreciate. The securities returned
1.89 percent this year, rebounding from a 9.4 percent plunge in 2013 and outperforming the broader market for U.S. government debt, index data compiled by Bank of America Merrill Lynch show.
Swaps traders have pushed forward expectations for the Fed’s first interest-rate increase since adopting extraordinary monetary stimulus to about June 2015, from September 2015 on March 7.
The Fed has kept its target for federal funds, the rate banks charge each other on overnight loans, in a range of zero to 0.25 percent since 2008.
“The fundamentals look incredibly weak, no big spike in oil or food to serve as a catalyst,” BNP’s Kohli said. “There is no sense of urgency in the inflation markets, and without that sense of urgency, and with the Fed being more hawkish, there is little to boost demand for inflation protection.”