Bill Gross (Pimco) & Franklin Buy Massive # of TIPS - Sign of Fed Rate Hike Concerns

Discussion in 'Wall St. News' started by ByLoSellHi, Feb 25, 2007.

  1. Pimco, Franklin Heed Bernanke, Buy Inflation-Protected Bonds

    By Deborah Finestone

    Feb. 26 (Bloomberg) -- Treasury notes that protect investors from an increase in consumer prices are posting their biggest gains in three years as fund managers from Franklin Resources Inc. to Pacific Asset Management Co. grow increasingly concerned inflation will accelerate.

    Treasury inflation-protected securities, or TIPS, have returned 1.15 percent this year, compared with a loss of 0.3 percent last year and a gain of 0.29 percent in 2005 during the same periods, according to data complied by Merrill Lynch & Co. By contrast, regular Treasuries are up 0.78 percent this year.

    The investors are hedging their bets as Federal Reserve Chairman Ben S. Bernanke warns inflation remains a risk. The difference between yields on TIPS maturing in one year and comparable Treasuries has jumped to 2.79 percent from 2.46 percent at the end of 2006, the highest since June. The so- called breakeven rate suggests investors anticipate inflation will average that amount over the next 12 months.

    ``Even in a low inflation environment, it's prudent for an investor to have something that protects them against upward spikes,'' said Tony Coffey, who helps manage $12 billion in assets at Franklin Resources in San Mateo, California. ``We've been buying more'' longer-maturity TIPS over the last three months.

    Inflation remains a ``predominant concern'' of Fed policy makers, according to a statement released Feb. 21 that detailed the minutes of the Jan. 31 meeting of the Federal Open Market Committee. U.S. consumer prices rose more than forecast in January, giving credence to Bernanke's comments to Congress on Feb. 14 that inflation is the central bank's primary concern.

    `Surprise Potential'

    The consumer price index increased 0.2 percent, the Labor Department said Feb. 21. Prices excluding food and energy rose 0.3 percent, the most since June. Inflation erodes the value of a bond's fixed payments.

    ``The surprise potential for significantly higher inflation is bigger than one of disappearing inflation,'' said Philipp Buechler, who helps oversee the equivalent $1.13 billion at Credit Suisse Asset Management in Zurich. ``TIPS are quite attractive and imply optimistic inflation assumptions.''

    The yield on the benchmark 10-year yield fell 2 basis points, or 0.02 percentage point, to 4.67 percent last week, according to bond broker Cantor Fitzgerald LP. The price of the 4 5/8 percent security due in February 2017 rose 1/8, or $1.25 per $1,000 face amount, to 99 20/32.

    The breakeven rate between inflation-linked and regular 10-year notes widened 4 basis points last week to 2.38 percent. They hit an 18-month low of 2.25 percentage points on Jan. 4 amid declining oil prices. Over the last five years, the highest was 2.78 percentage points, in March 2005.

    ``We're at the lower end of that range,'' said Donald Ellenberger, who oversees about $6 billion as co-head of government and mortgage-backed securities at Federated Investors in Pittsburgh. ``They look a little cheap to us.''

    Market Headwinds

    Inflation-protected securities had fallen out of favor with investors as the combination of 17 consecutive Fed interest-rate increases and stable inflation the past two years.

    TIPS funds were the worst performers for fixed-income investors last year, according to Chicago-based Morningstar Inc., returning on average 0.08 percent compared with 3.48 percent for intermediate government bond funds.

    ``There are still some headwinds for the TIPS market,'' said Ken Volpert, who runs a $10 billion TIPS fund and is principal head of Malvern, Pennsylvania-based Vanguard Group's bond indexing group. ``The economy has been slowing down and may slow further, which results in less inflation because the demand for goods is not as strong. Plus, energy has come off quite a bit.''

    Preferred Measure

    Crude oil prices have declined 22 percent from a record high of $78.40 a barrel in July. Oil touched $61.80 a barrel on Feb. 23, the highest price this year, on speculation U.S. fuel inventories will plunge in the weeks ahead as refineries close for repairs.

    Bernanke told the Senate Banking Committee on Feb. 14 that he continues to expect the economy will grow at a moderate pace this year and next as core inflation subsides.

    Core inflation -- as measured by the personal consumption expenditure price index, less food and energy items -- will decline to 2 percent to 2.25 percent this year and 1.75 percent to 2 percent in 2008, Bernanke said.

    If core inflation is still higher than Fed officials would like, Bernanke said central bankers are ``prepared to take action to address inflation risks if developments warrant.''

    Bernanke's warning last month that the U.S. government may face a ``fiscal crisis'' in the coming decades if it fails to deal with the rising costs of retirement and medical benefits makes TIPS even more attractive, said John Brynjolfsson, who manages $50 billion of inflation-linked debt at Pacific Investment Management Co. in Newport Beach, California.

    `Demographic Tension'

    Under Congressional Budget Office projections, the ratio of federal debt held by the public to gross domestic product will rise to about 100 percent in 2030 from about 37 percent now, Bernanke said at a budget hearing on Jan. 18. The expansion of debt would lead to a crisis that could only be addressed by deep spending cuts or large tax increases, he said.

    ``On a longer-term basis, TIPS are quite attractive,'' said Brynjolfsson, who purchased some of the 20-year securities sold by the Treasury last month. ``Demographic tension will create more inflation problems.''
  2. very interesting...Where is a good place to see a chart of the TIPS spread ?..Larry Kudlow always says this hasn't been widening, so he sees low inflation...
  3. rosy2


    for the past 2 years pimco has been saying rates were going down (as they went up). now they finanlly change their tune and say rates are going up. My conclusion is buy bonds.
  4. Bill Gross is not stupid.

    That's why all of this amazingly confusing: Fed has a dovish tone on inflation, IMO, and PIMCO allocates a huge block into TIPS.

    There's a serious misinterpretation or surprise lurking somewhere.
  5. rosy2


    heres a 10yr/tip spread chart
  6. Instead of focusing on inflation, maybe it means we're on the verge of a deflationary environment. Treasury bonds would be expected to do well against that backdrop but TIPS, according to their design, would lose a lot of value. If there has to be a "final fool" at the top of the TIPS market, let it be Bill, Ben and Ben.
  7. rosy2


    good point. and after last week, i think the US will resemble japan's deflationary environment
  8. how? its not in inflation #s. Wages are up, consumption is up, etc. Furthermore, Japan consumption is up as well.
  9. Gross sure made buku $$$ this week, huh?
  10. maybe not
    #10     Mar 3, 2007