Bond Traders Face Inflation Gamble That Will Last a GenerationBy
Treasury to auction $5 billion of 30-year TIPS this week
As core CPI misses estimates, yield curve flattest since 2007
If you’re a bond trader and agree with the Federal Reserve that low inflation is only transitory, then the Treasury has quite a deal for you.
The U.S. will offer $5 billion of 30-year Treasury Inflation Protected Securities on Thursday, the third and final opportunity to buy them at auction this year. For those concerned that accelerating price growth will erode fixed-income returns, they’re a must-have hedge.
The problem is that the latest inflation readings disappointed yet again. The core consumer price index rose 1.7 percent in September from a year earlier, missing estimates for 1.8 percent growth, according to the data released Oct. 13. That sent the 30-year breakeven rate, a market gauge of inflation expectations, down from its highest close since May, to about 1.93 percentage points.
For investors, the questions around inflation, which Fed Chair Janet Yellen on Sunday called “the biggest surprise in the U.S. economy this year,” have repercussions outside the TIPS market. The yield curve from five to 30 years reached the flattest since 2007 last week, as central-bank officials appeared determined to raise rates in December, regardless of whether price growth is at their 2 percent target. Some money managers are raising the specter of the curve eventually inverting, a time-tested signal of an impending recession.
“While the Fed will surely stress the ‘mysterious’ nature of low inflation, we are increasingly concerned that the FOMC’s insistence on pushing toward a December rate hike risks a policy-error,” BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote on Oct. 13, after the latest inflation readings.
The market-implied odds that the Fed raises rates by year-end are about 70 percent, slightly lower on the week. Strategists including Justin Lederer at Cantor Fitzgerald said they still expect a move in December, in part because hurricanes influenced the latest employment and inflation figures.
Those expectations are reflected in the two-year Treasury yield, which at roughly 1.5 percent is near the highest since 2008. Meanwhile, the benchmark 10-year yield fell almost nine basis points last week to 2.27 percent. It was the first weekly decline in five weeks, as traders pulled back from the 2.4 percent level that Janus Henderson Group’s Bill Gross said could spell the end of the bond bull market.
“We continue to flatten -- the long end holds in here, and you see slightly higher yields on the short end with the Fed in play,” Lederer said.
And as for that 30-year TIPS offering, it may be hard to match the enthusiasm seen at the June auction. Demand at that sale was the strongest since 2011 as inflation expectations plunged to pre-election lows. Now the bonds aren’t quite as cheap.
“It’ll definitely be interesting what type of appetite there is with breakevens at these levels,” Lederer said. “There are still buyers out there looking for inflation to pick up. But it’s the long end, it’s always a crapshoot.”
What to Watch
- It’s a light week for economic data
- Oct. 16: Empire State manufacturing survey
- Oct. 17: Import and export price indexes, industrial production, capacity utilization, NAHB housing market index, TIC flows
- Oct. 18: MBA mortgage applications, housing starts, building permits, Beige Book
- Oct. 19: Initial jobless claims, continuing claims, Philadelphia Fed business outlook, Bloomberg consumer comfort, Bloomberg economic expectations, leading index
- Oct. 20: Existing home sales
- A few Fed speakers are lined up, most notably Chair Yellen
- Oct. 17: Harker speaks on equitable transit
- Oct. 18: Dudley and Kaplan discuss economic development
- Oct. 19: George speaks in Oklahoma
- Oct. 20: Mester speaks on global regulatory structure, then Yellen speaks in Washington that evening
- Aside from bill auctions, the only Treasury issuance comes Oct. 19, via the $5 billion of 30-year TIPS