Reign of inflation-linked bonds likely to continue


Published — Saturday 8 December 2012

Last update 8 December 2012 2:16 am

| نسخة PDF Print News | A A

NEW YORK: Inflation in the US has been tame in the last few years, but there’s been just enough for bonds linked to the rise in prices to beat most other bond investments — a trend that should continue in 2013.
Bonds linked to inflation, known as Treasury Inflation-Protected Securities (TIPS), will likely deliver less impressive returns in 2013 with their yields stuck in negative territory, but big bond investors say don’t bet against them yet because of the Federal Reserve.
TIPS are on track to beat Treasuries for a fourth straight year, the longest such streak since 2001 to 2005. In the past three years, TIPS managed an average annual return of 10.4 percent, surpassing the 4.0 percent average return on regular Treasuries, according to Barclays.
“It’s going to be a struggle to repeat the performances we have seen the last three years, but I still see tremendous value in owning TIPS as opposed to other fixed income assets because all rates are low,” said Martin Hegarty, co-head of BlackRock’s inflation-linked bond portfolios in New York.
The US central bank, led by Chairman Ben Bernanke, has been pumping cash into bonds in a bid to reduce high unemployment and boost economic demand.
It has bought billions in bonds each month since late 2008, causing its balance sheet to balloon to $ 2.86 trillion. Because of that, virtually all US interest rates are hovering at historic lows.
“They have drawn long-term interest rates lower and they will hold them there until there’s a sustained growth trajectory,” said Gemma Wright-Casparius at Vanguard in Malvern, Pennsylvania, who runs the $ 44.8 billion Vanguard Inflation-Protected Fund, the biggest US TIPS mutual fund.
The Fed is widely expected to decide to continue its bond purchases at its policy meeting next week.
The Fed’s bond buying has elevated prices of oil, food and other commodities. This has generated enough inflation to allow TIPS — whose principal and interest payments adjust against the US Consumer Price Index — to outpace Treasuries and most other US bonds since 2008.
With TIPS, most of their yields, dubbed “real” yields, have been treading in negative territory, which makes them pricey.
The “real” yields on a 10-year TIPS typically match the expectations for long-term US economic growth, which had averaged 3.5 percent to 4.0 percent before the Great Recession.
But the sluggish growth rate during the current recovery and the Fed’s quantitative easing have skewed the 10-year TIPS yield, so it does not reflect traders’ US growth outlook.
So how have TIPS, with their negative yields, managed to generate higher returns than most other US debt with the exception of corporate bonds?
Thank the Fed for propping up inflation expectations.
Investors use so-called breakeven rates to express their inflation view. Breakeven rates represent the gap between the “real” yields on TIPS and the yields on regular Treasuries.
On Thursday, 10-year inflation expectations stood at 2.46 percent, higher than the year-over-year inflation rate of 2.2 percent in October. With the Fed buying a tremendous amount of government bonds, it has boosted expectations for future inflation.
As long as the CPI remains positive, the government will provide positive adjustments on principal and interest payments on TIPS, boosting their overall returns.
How much inflation adjustments will enhance TIPS returns going forward is impossible to predict with certainty, but it is estimated that at least a third of their future return will be tied to CPI adjustments.
Even though the TIPS sector has become pricey, the longest TIPS maturities still have potential for their yields to fall further. Fund managers say investors have not fully priced in the inflation risk from the easy monetary policies that the Fed and other major central banks have pursued.
“If real yields go lower, the 30-year will lead the charge because there is a significant grab for duration,” BlackRock’s Hegarty said.
The 30-year TIPS breakeven rate is 2.47 percent, essentially the same as the 10-year TIPS rate, suggesting traders are not demanding additional inflation premiums for another 20 years.
Buying “30-year breakevens make a lot of sense. There should be more of a risk premium out given how accommodative Fed and global monetary policy is,” said Bill Irving, a portfolio manager with Fidelity Investments in Merrimack, New Hampshire, who oversees about $45 billion in bonds.
While TIPS fund managers interviewed were confident TIPS will continue to beat Treasuries next year, they were less so about the overall return of TIPS.
“I won’t say it’s the end of the run for TIPS. I think there is still a decent potential to outperform Treasuries, but I think both of them have the risk of posting negative returns,” Fidelity’s Irving said.

If US growth and inflation were to accelerate due to say an orderly resolution of the “fiscal cliff” dispute over the federal budget, all bonds including TIPS could become less appealing as investors look to stocks and other growth-oriented investments.
Rather than owning a traditional TIPS fund, investors might consider other bond alternatives. AllianceBernstein offers a “TIPS-plus” portfolio that is a mix of TIPS, corporate and other types of bonds. This strategy offers inflation protection but reduces the interest-rate risk on TIPS if yields spike higher.
Another approach to reduce interest-rate risk on TIPS is beef up on short-dated issues. While shorter-maturity TIPS promise lower returns, their value erodes less as yields rise.

What's happening around Saudi Arabia

RIYADH: Foreign Minister Adel Al-Jubeir said on Thursday that a military option in Syria was still viable and support for the opposition fighting to oust President Bashar Assad would continue.Speaking at a news conference with visiting Austrian Forei...
JEDDAH: Violators of traffic regulations will soon have their licenses withdrawn and be sent back to driving school, according to the Traffic Department.Brig. Gen. Ali Al-Rashidi, the department’s spokesman, said the new regulations would come into f...
JEDDAH: The Labor Ministry has announced that it plans to ensure that only Saudis are hired for data entry jobs in eight sectors of the economy over the next two years.The plan is to create jobs for Saudis but also ensure that customer data is protec...
RIYADH: Saudi Arabia blacklisted on Thursday 12 people for supporting and financing Hezbollah’s activities in the Middle East, according to the Ministry of Interior.The people were described as “leaders and officials” from Hezbollah, which was declar...
JEDDAH: Police plan to detain 38 landlords who provided shelter for 351 illegals, including several wanted criminals. Jeddah police already arrested four landlords during raids Wednesday in several districts where illegal expats gather. The raids wer...
JEDDAH: It is the Islamic duty of all citizens to protect the security of their nation, according to Grand Mufti Sheikh Abdul Aziz Al-Asheikh.Al-Asheikh said that scholars and preachers are required by Islamic law to address problems facing society,...
RIYADH: Prince Sultan University students will launch an application on Dec. 9 for emergency medical services, which would link patients with ambulances.The app would allow people to share their locations, determine the time for an ambulance to arriv...
RIYADH: A man and a woman died in the past 24 hours in rain-related incidents as the capital was lashed by heavy rains. Four more patients also died in the central hospital due to respiratory problems due to the cold weather.Riyadh Civil Defense spok...
RIYADH: The King Salman Center for Relief and Humanitarian Works (KSCRHW) has started implementing a directive to distribute 200,000 lambs to Yemenis in the Hadramout province.“The aid came within an integrated program for the alleviation of the suff...
MADINAH: The Board of Forensics Medicine in Madinah has cleared a hospital here of negligence involving the death of a citizen at its facility, citing lack of evidence and that the defendants, two consultants, failed to turn up for the hearing.The fa...
JEDDAH: A young Saudi man has won an international innovation award for inventing a “smart boat” that can monitor sea pollution.Abdulaziz bin Mashhoor Al-Shammakhi won the award with 20 young people who were selected from among 700 participants from...
JEDDAH: Umrah pilgrims can expect to save between 10 and 15 percent on the cost of their hotels under a new electronic booking system that cuts out intermediaries.This is according to Abdullah Qadi, deputy president of the national committee for Haj...
RIYADH: Surgery performed at King Khalid Hospital in Najran made a 40-year-old Saudi woman regain her sight which was lost eight months ago.Hospital General Supervisor Abdo Al-Zobayri said here that the patient had lost her sight eight months ago bec...
RIYADH: More than 200,000 women were tested for breast cancer and only 15 positive cases were detected in the capital during the monthlong campaign to fight breast cancer which ended here on Tuesday.Speaking at the closing ceremony of the campaign, D...
KUWAIT: Kuwaiti Minister of Commerce and Industry Yusuf Al-Ali issued a decree to ban the import of all types of livestock including cows, goats, sheep, giraffes, camels, lamas, antelopes, and others from markets including Saudi Arabia, France and Sl...

Events & Exhibitions

Stay Connected