TIPS under water again?

There is a growing perception among bond strategists and investors that the good performance of inflation-protected securities (known as TIPS) since 2009 is at risk.

Firms, including UBS Group AG and Aberdeen Asset Management, say monthly purchases of $ 120 billion in Federal Reserve bonds have disproportionately benefited TIPS’s relatively under-traded market, pushing their yields to deeply negative levels.

Meanwhile, investors are pouring an unprecedented amount of money into funds that invest in securities, seeking protection from rising inflation. Both pillars, which are at the heart of the $ 1.6 trillion TIPS market, are now under pressure.

The Federal Reserve, which is holding back debt through quantitative easing, is signaling it could cut purchases this year. Meanwhile, inflation is showing signs of peaking, potentially reducing the demand for TIPS as a hedge.

Inflation expectations fell on Tuesday after a report showed the smallest increase in consumer prices in seven months. Data coming before next Federal Reserve collection next week could give the central bank a break in reducing its decision, easing calls for a reduction in QE immediately after this month.

“The demand for inflation-linked securities has passed through the roof over the past 15 months as core inflation has risen,” said Bhanu Baweya, chief strategist at UBS. “The supply of TIPS is declining because the Fed is intervening through QE. Both will change. “

Calling TIPS one of the most highly valued assets, Baweja predicts that 10-year real returns will rise by 50 basis points in the coming months, from the current level of about minus 1%.

Billionaire’s money manager Jeffrey Gundlach, chief investment officer at DoubleLine Capital LP, said in an online presentation on Tuesday that he thought TIPS looked “quite expensive” at current levels.

The yield on 10-year TIPS, known as real income, is seen as a pure reading of growth as it eliminates inflation. They reached a record low of minus 1.2% last month and have risen by about 20 basis points since then, giving weight to the view that real returns — and potential growth expectations — have finally bottomed out.

Purchases of Fed bonds designed to boost the economy and keep the bond market running smoothly left 22% of outstanding TIPS, up from about 9% in February 2020.

Artificial push

A side effect of buying Federal Reserve bonds is that it may have artificially increased rate of return, a widely followed indicator of inflation expectations. The ten-year rate of return — calculated by subtracting TIPS returns from nominal ones — is about 2.3 percent, after reaching an approximately eight-year high of nearly 2.6 percent in May.

“True” inflation expectations are between 1.8% and 1.9% after the abolition of the liquidity premium caused by Fed purchases, Deutsche Bank AG strategist Stephen Zeng wrote in a note on September 10. This premium may fade rather slowly: if the TIPS market grows at its current rate, it will take 12 years for the Fed’s share to retreat to pre-pandemic levels, according to Deutsche estimates.

James Atty, who manages $ 5 billion in fixed-income assets in Aberdeen, said he was betting that real returns would rise when the Fed withdrew from the market at a time when TIPS investor positions were still crowded.

Strongly distorted by the Fed, TIPS will “suffer as a result of the QE downgrade,” he said.


 Junior Trader Nikolay Yordanov


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