BlackRock, Pimco Issue Inflation Warnings Ahead of TIPS Auction

  • U.S. selling $11 billion of 10-year inflation-linked debt
  • Nominal Treasuries fall as Yellen says Fed close to rate hike

The roster of firms lining up to recommend Treasury Inflation Protected Securities before a sale of the debt on Thursday is starting to look like a "Who’s Who" of bond giants.

BlackRock Inc., Fidelity Investments and Pacific Investment Management Co., which oversee almost $9 trillion combined, have all issued warnings that consumer-price gains will accelerate and are endorsing TIPS after U.S. President-elect Donald Trump’s victory. DoubleLine Capital LP’s Jeffrey Gundlach and Goldman Sachs Asset Management began recommending the securities last month, amid signs costs in the economy were picking up.

While U.S. inflation has trailed the Federal Reserve’s 2 percent target for more than four years, Trump’s infrastructure spending pledges are fueling expectations of a pickup. TIPS have returned 4.9 percent this year as of Nov. 15, versus 1.8 percent for nominal Treasuries, based on Bloomberg Barclays index data. The outcome of the $11 billion 10-year TIPS auction Thursday will offer a verdict on the staying power of the reflation trade, in the face of global headwinds including tepid economic growth in Europe.

"After this election year, it’s likely that the inflation will move higher -- fiscal stimulus and protectionism are inflationary," said Mihir Worah, co-manager of the $83 billion Pimco Total Return Fund in Newport Beach, California. TIPS “will outperform Treasuries again next year."

Yellen Speaks

Fixed-rate Treasuries fell Thursday as Fed Chair Janet Yellen signaled the U.S. central bank is close to lifting interest rates, while reiterating that the future path of increases will likely be gradual. U.S. new-home construction jumped to a nine-year high in October as an outsized advance in the number of apartment projects accompanied a strong pickup for single-family housing, a Commerce Department report showed Thursday

Benchmark Treasury 10-year note yields climbed two basis points, or 0.02 percentage point, to 2.24 percent as of 11:10 a.m. in New York, according to Bloomberg Bond Trader data. The 2 percent security due in November 2026 slipped 5/32, or $1.56 per $1,000 face amount, to 97 27/32.

Longer-dated bonds led losses as Yellen told U.S. lawmakers Thursday that a rate hike could come relatively soon as the U.S. economy continues to create jobs at a healthy clip and inflation inches higher.

Read more: Trump spending proposals may spur inflation.

A bond-market gauge of expectations for U.S. consumer prices over the next decade climbed this week to the highest since April 2015. The measure, known as the break-even rate, which represents the extra yield investors demand on regular 10-year notes over similar-maturity TIPS, reached 1.97 percentage points. The difference has risen from below 1.2 percentage points in February. The debt pays interest on a principal amount that rises with consumer prices.

The president-elect’s pledges include tax cuts and spending $500 billion or more over a decade on infrastructure, a combination that’s seen as spurring quicker growth and inflation in the world’s biggest economy. Trump has also blamed China and Mexico for American job losses and threatened punitive tariffs on imports.

The Wall Street consensus is for inflation to accelerate. The U.S. consumer-price index will climb to 2.2 percent in 2017, from 1.2 percent this year, according to the median forecast of economists surveyed by Bloomberg.

“TIPS have an important place in portfolios today,” Rick Rieder, chief investment officer for global fixed income at BlackRock, which oversees $5.1 trillion, wrote in a report after the election. “We are probably going to see a significant shift from monetary policy stimulus to fiscal policy initiatives. This may well aid in accelerating the pick-up in inflation.”

Pimco, which oversees about $1.5 trillion, has been warning about the prospect of inflation since last year. It reiterated its TIPS recommendation after Trump’s surprise victory in the Nov. 8 vote. Gundlach, co-founder of DoubleLine Capital in Los Angeles, who predicted Trump’s election, recommended TIPS in October. Goldman Sachs Asset Management did the same last month.

There are some forces that may restrain inflation. For one thing, the dollar is surging as bets mount on a quicker pace of Fed rate increases. A gauge of the greenback against 10 major peers reached the highest since February on Wednesday, raising the prospect that a stronger U.S. currency will keep down import prices. The economic momentum at home may also be buffeted by limp global demand.

‘Deflationary Headwinds’

“There’s a case to be made for inflation,” said Ed Al-Hussainy, senior global interest-rate analyst at Minneapolis-based Columbia Threadneedle Investments, which oversees $460 billion. “But external deflationary headwinds are still with us,” such as weak growth in Europe and the stronger dollar.

At the most recent auction of inflation-linked Treasury securities, on Oct. 20, investors showed limited interest. The $5 billion sale of 30-year TIPS drew the second-lowest demand since 2010, as measured by the bid-to-cover ratio.

Of course, that was before the election result sent shockwaves through financial markets and upended investors’ assumptions about the outlook for economic growth and inflation.

Fidelity, which manages $2.1 trillion, is in the camp anticipating higher U.S. government spending will push up inflation.

“TIPS may benefit from rising inflation expectations,” Bill Irving, co-manager of the Fidelity Government Income Fund, wrote in a report on the company’s website following the vote.

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