Investors See No Inflation Buying Bonds on ISM’s Growth Surprise

Bond investors are showing little concern that inflation will accelerate even with the Institute for Supply Management’s manufacturing index unexpectedly rose to the the highest level in more than three years.

Investor withdrawals yesterday from exchange-traded funds that invest in U.S. government debt have been concentrated in securities due in three years or less, while buyers continue to add longer-maturity bonds. ETFs that invest in Treasury Inflation-Protected Securities saw $15.8 million in outflows, data compiled by Bloomberg show.

“One of the reasons the yield curve is flattening is there is no inflation,” said Thomas di Galoma, head of fixed income rates at ED&F Man Capital Markets in New York. “Real returns are very high, and there’s nowhere to put your money but the long end of the market.”

The gap between yields on five- and 30-year U.S. Treasury securities narrowed to 1.42 percentage points, or 142 basis points, on Aug. 28, the least 2009. The curve, which plots the difference between yields on various maturities, was 148 basis points today.

Investors typically demand a higher yield premium on longer-maturity debt to guard against the thread of inflation while the economy expands. Consumer prices using the Federal Reserve’s preferred gauge have risen less than its 2 percent target for 27 months.

Fund Flows

The $1.4 billion in withdrawals yesterday from all U.S. government bond ETFs were a reversal of last month’s gains, when U.S. government ETF investors gained $4.9 billion out of $8.2 billion in all domestic fixed income inflows in August, data compiled by Bloomberg show. For the year, Treasury ETFs have drawn $9.1 billion.

The Institute for Supply Management’s index unexpectedly climbed to 59, the highest level since March 2011, from July’s 57.1, the Tempe, Arizona-based group reported yesterday. Readings greater than 50 indicate growth. The median forecast in a Bloomberg survey of economists was 57.

American factories are benefiting from a rebound in auto sales and stronger business spending on new plants and equipment that are helping industries rise above the political tensions weighing on Europe. Faster wage growth is now needed to sustain the advance and broaden household purchases beyond automobiles.

While consumer prices have risen by at least 2 percent in each of the four months from April through July, the most recent data, the inflation rate forecast by TIPS traders by measuring the gap between yields indexed for inflation and non-indexed yields has remained contained.

The five-year break-even rate of inflation, as the gap is known, is 1.86 percentage points, down from 2.11 percentage points June 24, and compared with an average of 1.95 percentage points for the year.

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