Loser Bonds Lure Buyers Betting Ron Paul Will be Right

Eventually, Ron Paul will be proven right.

That has to be the thinking for investors tiptoeing back into bond funds that benefit from rising costs on everything from rent to eggs.

The surge in consumer prices that Paul and his Republican colleagues in Congress predicted the Federal Reserve would fuel has yet to materialize, making inflation-protected bonds one of the worst performers of late. Funds that buy the debt lost 3.9 percent in the past year and faced $16.2 billion of withdrawals in 2013, Morningstar Inc. and EPFR Global data show.

Now that the economy’s looking up, the money’s starting to trickle back in. After a stretch from April 2013 through the end of the year with not one week of inflows, inflation-protected bond funds have logged six weeks of net deposits in 2014, EPFR data show. They received $245.9 million of new cash in the two weeks ended May 7, the second time in the last year that they had consecutive inflows.

Inflation is “off the backburner” and will start accelerating within the next few months, Royal Bank of Scotland Group Plc strategists led by John Briggs predicted last week. A couple of days earlier, BlackRock Inc.’s Jeffrey Rosenberg said the firm forecasts “modestly rising inflation this year.”

Prices paid to American factories and service producers on goods from chickens to trucks rose 0.6 percent in April, the most since September 2012, figures from the U.S. Labor Department showed today.

Bond Bogeyman

When consumer prices rise too quickly, it’s generally bad for conventional bonds, so investors seek out specialized debt with coupon payments tied to cost-of-living increases.

Inflation has been the bond-market bogeyman that hasn’t shown up since the crisis, despite the Fed’s best efforts. Prices rose 1.1 percent in the year ended in March, below the U.S. central bank’s 2 percent target, according to the personal consumption expenditures price index.

Regardless of the criticism from Paul, the former Texas Representative, and others, the Fed has been more focused on preventing consumer prices from going down over the past three years, rather than preventing them from rising too quickly.

Harsh Backlash

The Fed’s second round of bond purchases, announced in November 2010, sparked the harshest political backlash against the institution in three decades. That hasn’t stopped policy makers from rolling out additional stimulus measures intended to boost growth since then.

Rosenberg, BlackRock’s chief investment strategist for fixed income, suggests Fed Chair Janet Yellen may have to switch tactics soon. The threat of deflation has “empowered the Fed to pursue unprecedented accommodative monetary policy,” he said. “That may now be about to change.”

And RBS strategists predict that an increase in consumer prices “will impact what we see as a high level of complacency in the markets in regards to inflation.”

So, maybe, Paul will finally be right. And bonds linked to inflation will be winners.

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