Just about everyone believes inflation is coming. But when will it actually get here?
Soon, if you listen to the trading in Treasury Inflation Protected Securities. The yield on five-year TIPS — government bonds that pay additional principal when consumer price inflation rises – closed at a record negative 0.44% Wednesday.
Buying a TIPS bond with a negative yield means locking in a certain loss if inflation fails to materialize. Inflation has been falling lately, as Fed officials have mentioned once or twice, and if it stays under wraps today’s buyer of $100 in five-year TIPS can hope to receive a princely $99.56 in 2015.
That’s hardly the deal of a lifetime if you accept Federal Reserve chief Ben Bernanke’s pledge to both restore economic growth and keep prices stable. But negative TIPS yields say fewer and fewer investors think Bernanke & Co. will be able to keep the inflation genie in the bottle.
“People are paying up for inflation protection,” said David Merkel, principal of investment manager Aleph Investments in Maryland. “You can see inflation is going to be punk in the short run, but what is it likely to be in the long run?”
The yield on five-year TIPS closed below zero for the first time in August, after Fed officials started talking up another round of asset purchases known as quantitative easing. After a brief sell-off, they dropped back into negative territory late last month and have stayed there.
With the recovery weakening and Fed officials talking increasingly of trying new ways to stimulate the economy, the run-from-inflation trade has gotten more popular. The yield on seven-year TIPS closed below zero this month for the first time.
The latest declines come as pessimism about the economy has sent prices soaring in commodities, another inflation hedge, and across the bond market, where investors seek income. Regular Treasury securities have been trading at record low yields as well.
Having already used up much of its ammunition, the Fed now hopes to use inflation to rouse the economy from its debt-induced slumber. Minutes of August’s meeting of the Federal Open Market Committee revealed officials are considering changes that might make it easier to boost inflation expectations, bringing down real interest rates and presumably stimulating growth.
One observer of Fed wonkishness pronounced this shift a game changer, though others remain skeptical that the central bank will be able to achieve its goals anytime soon.
“The Fed may have difficulty raising inflation expectations given the state of the economy,” said John Higgins, a London-based forecaster with Capital Economics. “At close to 10%, the unemployment rate is about twice the level widely considered to be consistent with a stable rate of inflation.”
And so it is with the TIPS rally. Buying inflation-protected bonds, even at a premium, seems like a decent idea right now, given all the talk of Helicopter Ben and the ever-present fears about the value of the dollar.
But any sure-thing investment can be tripped up by the timing. Even if you believe Bernanke will break through and get prices rolling higher, can he pull it off within five years?
“Eventually we will see real goods inflation,” said Merkel. “But we’re in an awkward environment, and things can get a lot nuttier. ”
