Pimco Says TIPS Have Further to Run as Morgan Stanley Sees Peak

  • Both investors say Trump has accelerated existing trends
  • TIPS beating nominal Treasuries for first time since 2012

A surge in inflation expectations triggered by Donald Trump’s election has rewarded investors who bet on U.S. bonds that protect against rising consumer prices. Pacific Investment Management Co. says there are gains ahead, while Morgan Stanley Investment Management isn’t so sure.

Both investors say Trump has accelerated a repricing of inflation risks that was already starting. Pimco says prices for Treasury Inflation Protected Securities are still short of the levels that reflect the cost-of-living increases that have been the norm over the long term. The securities have returned 4.6 percent this year through Nov. 23, versus 1.1 percent for conventional Treasuries. TIPS are outperforming for the first time since 2012.

“There’s a big rotation now into reflationary hedges,” said Mark Kiesel, chief investment officer for Pimco, which runs the world’s biggest actively run bond fund and is based in Newport Beach, California. “TIPS can run much further,” he said this week in an interview on Bloomberg Television. The company, with $1.55 trillion under management, has been recommending inflation-linked debt since at least 2014.

The gap between 10-year yields on TIPS and those on similar-dated conventional notes widened to as much as 1.98 percentage points this week, the most in more than two years. The so-called break-even rate shows what investors expect annual inflation will average over the lifetime of the debt.

The nominal 10-year note yielded 2.36 percent, after touching 2.41 percent this week, the highest since July of last year. The two-year yield reached 1.17 percent for the first time since 2010.

“Japanese investors are starting to think about investing at this level for Treasury yields, but they want to see when the trend higher will stop,” said Kazuaki Oh’E, head of fixed income at CIBC World Markets Japan Inc. in Tokyo. He said the next level he’s watching for the benchmark note is 2.5 percent.

While U.S. inflation has trailed the Federal Reserve’s 2 percent target for more than four years, expectations for a pickup started to gain momentum in September as commodity prices climbed. Trump’s infrastructure spending pledges are adding fuel to the move. 

Fair Value

The 10-year TIPS break-even rate of less than 2 is below the fair-value level of 2.3 or 2.4 based on the past 10 and 20 years, Kiesel said. That means the TIPS yield can fall by another 30 basis points to 40 basis points, he said.

With the break-even rate headed for its steepest quarterly increase since the first three months of 2012, Morgan Stanley Investment Management is concerned the advance is near a peak.

“TIPS are at a point where it’s difficult to rally more,” said Michael Kushma, chief investment officer for global fixed income at the company, which oversees $406 billion and has been overweight the securities since before the election. “We have felt that inflation risk is rising. Trump’s rise to power has accelerated that, the idea that he will bring forth some fiscal stimulus, which will raise the expected inflation rate over the next year or so,” he said in an interview in Singapore last week.

Pimco bases part of its call for sticking with TIPS on the increased uncertainties as the U.S. waits to see what the new president will do.

“Reflationary assets are under-owned by the marketplace,” Kiesel said.

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