From the Wall Street Journal:
Investors who have craved inflation seem close to getting some, and they are preparing
The inflation trade is back on Wall Street.*Previously:
With signs of rising prices around the globe, investors who for long craved inflation finally seem close to getting some, and they are preparing.
Demand is rising for a broad swath of financial assets that typically gain ground when consumer prices are expected to rise. The winners include inflation-protected government bonds in the developed world as well as commodities such as, oil, zinc, iron ore and aluminum.
U.S. mutual funds and exchange-traded funds targeting inflation-protected Treasurys, known as TIPS, drew $6.2 billion in new cash this year through Wednesday, headed for the biggest calendar-year inflow since 2011, according to fund tracker Lipper. The sector attracted $384.5 million new cash for the latest week, the most on a weekly basis since April. It has logged net inflows nine of the last 10 weeks.
TIPS increase their payout to holders if inflation measures exceed certain thresholds.
Market-based inflation expectations, reflecting yields on TIPS subtracted from the yields on nominal government bonds, hit their highest level in more than a year Thursday. In the U.S., the 10-year break-even rate—the yield premium investors demand to hold the 10-year Treasury note relative to the 10-year TIPS, hit 1.73%, indicating investors are banking on annual inflation in that range for a decade.
It hovered around that level Friday after a solid report on U.S. economic growth essentially matched the high expectations of bond investors. Faster growth generally should help lift prices of goods and services.
Nominal government bonds are bonds whose payouts aren’t adjusted for inflation. Inflation chips away fixed returns on bonds over time and is the main threat to long-term government bonds. So higher inflation expectation saps these bonds’ appeal.
The month-long selloff has sent the yield on the benchmark 10-year Treasury note to 1.852% Friday from 1.605% at the end of September, closing in on 2% for the first time since March.
“The bigger picture is that central banks around the world are actively trying to push inflation higher, so why not fight on the same side as the player with an unlimited balance sheet,” said Donald Ellenberger, head of multisector strategies at Federated Investors, which had $367.2 billion in assets under management at the end of June. Mr. Ellenberger said he is “overweight” TIPS, meaning he holds a greater portion than some bond indexes tracking this asset class, a typical way for portfolio managers to express a bullish view.
The market has begun shifting its focus toward the risks of rising prices, after several years dominated by fears of falling prices, or deflation. When price levels are rising, investors typically sell nominal bonds and purchase TIPS in a bid to protect purchasing power over time.
Though it has been years since rising prices were a problem for policy makers, there are signs the picture is growing more complicated. Wholesale inflation in China turned positive last month for the first time since 2012. The U.K.’s consumer-price index rose at the fastest pace last month in nearly two years. In the U.S., the CPI gained 1.5% in September, the biggest year-over-year increase since October 2014. The recovery of oil prices is helping to support higher inflation after two years of steep declines.
Adding to inflation-wary sentiment, top central-bank officials on both sides of the Atlantic, including Federal Reserve Chairwoman Janet Yellen, have signaled that they might tolerate inflation running slightly above target.
Investors say the uptick in inflation expectation should be welcomed by central banks that have been struggling for years to meet their inflation targets. It has been more than four years since the price measure watched by the Fed exceeded its 2% target.
The risk, say some analysts, is that inflation may continue to rise while economic growth stagnates, at a time when monetary stimulus is reaching limits....MUCH MORE
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