By Dakin Campbell and Gavin Finch
April 6 (Bloomberg) -- Bond investors are earning more than ever with Treasury Inflation Protected Securities as central bankers around the world set the stage for a rise in consumer prices by deploying unprecedented amounts of money to battle the global recession.
In March, TIPS earned 6.1 percent, the best returns since the Treasury started selling the securities in 1997, according to Merrill Lynch & Co. index data. Worldwide, inflation- protected bonds had the second best month in at least a decade, rising 4.3 percent including reinvested interest, the data show.
At BlackRock Inc., Vanguard Group Inc., Pacific Investment Management Co. and Pictet & Cie Banquiers, concerns are growing that policy makers will struggle to control inflation once economies start to recover. The Federal Reserve, Bank of England and European Central Bank have increased money supply by an average 9.2 percent in the past year, or the equivalent of $2 trillion, to $24 trillion, according to the broadest measure each uses.
In the U.S., the consumer price index “could go back to 4 percent or even higher,” said Brian Weinstein, who oversees $9 billion in inflation bonds at New York-based BlackRock, the largest publicly traded U.S. fund manager. At the least, “the TIPS market is showing that we’re going back to trend inflation,” he said.
Prices in the U.S. rose 0.1 percent last year, the slowest pace since 1954. The CPI will fall 0.7 percent in 2009, according to the median forecast in a Bloomberg survey of 52 economists.
Global Contraction
The Organization for Economic Co-operation and Development predicts the top 30 industrialized nations’ economies will contract 4.3 percent this year, the most in more than a half century. The median of 55 predictions in a Bloomberg survey shows the U.S. shrinking 2.5 percent, after declining 6.3 percent in 2008, the worst performance since 1982.
Governments and central banks in 19 of the largest developed countries are spending 43 percent of their average gross domestic product to end the worst crisis since the Great Depression, adjusting for cost-of-living variances, the International Monetary Fund said March 6. Monetary authorities in the U.S., U.K. and Japan have cut interest rates to near zero to revive their economies.
Second Best
That’s why prices are an increasing concern for investors around the world. While indexed bonds fell 3.1 percent in the second half of 2008, the only month that was better than March globally was in December, according to data tracked by Bloomberg since 1998.
“Pumping money into the system is very inflationary,” said Kenneth Volpert, who oversees $180 billion in taxable bonds, including $14 billion in a TIPS fund, for Vanguard in Malvern, Pennsylvania. “TIPS will outperform.”
The Treasury Department will sell $6 billion of 10-year TIPS tomorrow, and the U.K. will auction 1.1 billion pounds ($1.6 billion) of inflation-indexed bonds maturing in November 2032 on April 8.
Expectations for inflation by TIPS investors -- reflected in how much less yield they demand than buyers of traditional government debt -- are below historical averages, central bank target rates and the median prediction in Bloomberg surveys of economists.
Breakeven Rate
That so-called breakeven rate, which measures how much prices would have to rise for both securities to have equal returns, for 10-year bonds shows investors expect average inflation of 1.41 percent over the next decade, 0.65 points lower than the past decade’s 2.06 percent average.
Most Fed policy makers said in January that they favor 2 percent inflation, according to minutes of that month’s policy meeting released Feb. 18, the first time they have made what Chairman Ben S. Bernanke called “longer-term” CPI projections public.
The median prediction of 29 forecasters surveyed by Bloomberg shows inflation rising to 2.4 percent by the end of 2011, compared with February’s 0.2 percent rate, the Labor Department said. That means there’s room for TIPS prices to increase, widening the yield gap to something closer to current inflation expectations or higher, investors said.
John Brynjolfsson, the chief investment officer at Armored Wolf LLC figures Fed officials may aim for inflation as high as 6 percent as early as 2012, he said March 25 on Bloomberg Television.
Fed Price Measure
The so-called five-year, five-year forward breakeven rate, a measure that the Fed uses to measure price expectations, shows inflation’s 2014-19 average hitting 2 percent.
If the recession and deflation persist, inflation-linked securities will suffer. For now, the global economy is showing few signs of improving.
The U.S. unemployment rate jumped in March to 8.5 percent, the highest since 1983, and the economy lost more than 650,000 jobs for the fourth straight month, the Labor Department said April 3. The median response of 55 economists in a Bloomberg survey predicts 9.4 percent jobless rate by Dec. 31.
“Inflation is driven historically by wages and clearly if you have the unemployment rate rising, it begs the question where will you get inflation from,” said Chris Lupoli, executive director for global inflation-linked strategy at UBS AG in London. “We’re projecting that there will be a global healing but that the recovery will be anemic.”
Shrinking Slice
Inflation-linked debt is a shrinking slice of the market for government bonds in the U.S., where it makes up less than 9 percent of the $6 trillion of Treasuries, down from 11 percent in July.
“Inflation worldwide is going to surge in the years to come,” said Mickael Benhaim, who manages about $32 billion as head of global bonds at Pictet in Geneva. “On the supply side, issuance of the securities as a ratio of overall government debt is sharply declining,” which “makes linkers look very attractive,” he said.
Benhaim says there’s a shortage of inflation-linked debt in the U.K. too. There are about 180 billion pounds ($266 billion) of index-linked gilts outstanding, or 23 percent of the total debt, down from 30 percent a year ago, U.K. Debt Management Office data show.
In the euro region, where the ECB targets an inflation rate of just under 2 percent, the market totals about 250 billion euros ($336 billion), or 7 percent of all outstanding debt, down from 7.2 percent a year ago.
TIPS Cheapest
BlackRock’s Weinstein said TIPS are the cheapest inflation- linked bonds. Notes maturing in one, two and three years have the smallest breakeven rates outside of Japan, where deflation expectations persist through 2010’s first quarter, according to the median response in a Bloomberg survey of 16 economists.
“On a relative value basis, the U.S. inflation market is the one I would rather own,” Weinstein said. “If I could sell U.K. breakevens and European breakevens and buy U.S. breakevens, I would.”
Breakeven rates in U.K. are the highest among the most actively traded inflation-indexed bonds -- 3.29 percent on the 30-year, 2.85 percent on the 20-year and 2.67 percent on the 15- year, according to Bloomberg data. The 10-year’s 2.05 rate is 0.78 points below U.K.’s 2.83 percent average for the past decade. The Bank of England targets 2 percent inflation.
Fed Plans
Investors flocked to TIPS after March 18, when the Fed announced its latest attempt to boost the U.S. economy, including plans to buy up to $300 billion in Treasuries and TIPS and $850 billion in mortgage-related debt.
That money increased the amount the U.S. has spent, lent or committed to address the economic crisis to as much as $12.8 trillion, 90 percent of last year’s GDP. The money includes President Barack Obama’s $787 billion stimulus plan, which he signed into law on Feb. 17.
TIPS had lost 0.33 percent from the start of the year to the day before the Fed announcement. Since March 17, they have returned 3.3 percent, the Merrill index shows.
Even before the latest Fed announcement, investors were predicting inflation. Warren Buffett, the billionaire chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc., said March 12 that stimulus efforts “will probably cause a lot more inflation.” Chris Caltagirone and Bob Greer of Newport Beach, California-based Pimco said in a March 10 report that “inflation will rise.”
Price measures are starting to rise as investors bet government efforts will gain traction.
Rising Commodities
The Standard & Poor’s GSCI Index of 24 commodities rose in the first quarter for the first time since June. Crude oil has increased 62 percent to $52.51 a barrel from its low of $32.40 on Dec. 19. The Reuters/University of Michigan consumer sentiment index projects an inflation rate of 2 percent over the next 12 months and 2.6 percent over the next five years, according to the survey, released March 27.
The Fed’s plan to buy bonds “lays the groundwork for a recovery laced with inflation,” said Jim Caron, the global head of U.S. interest-rate strategy at Morgan Stanley in New York, in an April 3 note. “That could be hard to control.”
To contact the reporters on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net
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