Best-Performing Treasuries Suggest Inflation Threat is Real

Savvy bond investors aren’t waiting for more evidence of quicker inflation amid the debate over whether the U.S. economy will receive the jolt promised by the Trump administration.

While deliberations drag on about the merits of what’s become known as the Trump reflation trade, investors have been buying protection against a rise in consumer prices this month at the fastest pace since just after Donald Trump’s victory in November.

The iShares TIPS Bond ETF, the largest exchange-traded debt fund featuring Treasury Inflation Protected Securities, had $547 million of inflows during the past two weeks, according to data compiled by Bloomberg. The 10 largest TIPS ETFs have seen aggregate net inflows in each of the last 10 weeks.

“All roads point to a firming in inflation,” said Tom Porcelli, the chief U.S. economist at RBC Capital Markets LLC in New York. “Demand for TIPS tells you what people are thinking and feeling for the here-and-now about inflation. If you want to use it as a barometer of how people are gauging or viewing inflation, it does a good job.”

That bodes well for Treasury as it prepares to sell $7 billion of 30-year TIPS by auction Thursday. And that’s after a report showed Tuesday that U.S. wholesale prices jumped in January by the most since September 2012. Consumer prices likely rose 2.4 percent on an annual basis, according to analysts’ forecasts before Wednesday’s report.

The last auction of TIPS was on Jan. 19, when the Treasury sold $13 billion of 10-year securities. Bidder-participation metrics and the auction yield revealed strong demand, with investors such as foreign central banks and mutual funds scooping up 84 percent of the offering, leaving primary dealers with little supply to absorb.

Thirty-year TIPS were last sold by the Treasury on Oct. 20.

TIPS have returned 0.73 percent this year, compared with 0.33 percent for nominal Treasuries, based on Bloomberg Barclays index data.

For all of 2016, the iShares $22 billion TIPS ETF pulled in $6 billion -- the second-biggest windfall of all bond ETFs and returned 3.6 percent, the most in three years.

A favored bond-market measure of expectations for consumer prices based on TIPS, known as the break-even rate, has risen to above 2 percent for most maturities -- including the 30-year which is at 2.16 percent, versus 1.9 percent on Nov. 8.

The post-election surge in U.S. assets slowed after wage growth proved disappointing in January. This, and little in the way of concrete initiatives by Trump early in the year, brought the reflation trade into question. That faith was rekindled last week after Trump promised a “phenomenal” tax plan to be announced in coming weeks.

U.S. households, for their part, also envision price pressures will march higher. Expectations for consumer price inflation rose to the highest level since mid-2015, according to a New York Fed survey released Monday. The median respondent reported an expected inflation rate last month of 2.9 percent three years ahead, up from 2.8 percent in December.

“It makes sense to be long some inflation exposure in this market,” said Subadra Rajappa, head of U.S. interest-rate strategy at Societe Generale SA in New York. There is money flowing into TIPS funds “given people’s view that there are going to be more reflationary policies put in place with the new administration.”’

— With assistance by Rachel Evans