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RBC's Latter: TIPS Offer Cheap Inflation Protection

Thursday, 08 Sep 2011 06:51 PM

U.S. inflation-protected debt is attractive as the risk that the global economy is returning to recession overtakes concern simulative monetary policies will boost consumer prices, according to RBC Global Asset Management’s Gordon Latter.

Investors have reduced their expectations for inflation as measured by the difference in yields on Treasury Inflation- Protected Securities, or TIPS, and Treasuries to almost the lowest level since October 2010. The break-even rate on 10-year securities has dropped to 2.02 percent from a high this year of 2.67 percent reached on April 11.

“The world is short inflation protection,” Latter, who serves as managing director of risk-based solutions in Minneapolis, said at the Bloomberg Global Inflation Conference in New York hosted by Bloomberg Link. “You can’t get enough inflation product.”

Central banks from the Federal Reserve to the Bank of England have kept interest rates at record lows since the start of the 2008 financial crisis. The Fed has purchased $2.35 trillion of debt in an effort to stimulate the economy and the Bank of Japan and Swiss National Bank have each intervened in the currency market to try to curb their currencies’ appreciation.

‘Waste of Money’

“There is a lot of inflation hysteria,” Ari Bergmann, managing principal at New York-based risk management adviser Penso Advisors, said at the conference. “Hedging, in my experience over the last 25 years, never works and is a waste of money.”

Five-year break-evens for the U.S., Germany and France are all under 1.7 percent, indicating there is little inflation concern in the coming half-decade, while those for Japan remain negative. Inflation-linked government bonds worldwide underperformed nominal sovereign debt last month by 1.282 percentage points, the most since February 2009, according to Bank of America Merrill Lynch indexes.

The fixed-interest payment on 10-year TIPS turned negative for the first time on Aug. 9 after Fed officials said they’ll keep benchmark interest rates at record lows through mid-2013 with economic growth stagnating.

Inflation Adjustment

Holders of TIPS receive an adjustment to the principal value of their securities equal to the change in the consumer price index, in addition to a fixed rate of interest that’s smaller than the interest paid to a holder of conventional debt. The difference is known as the breakeven rate.

U.S. inflation has been running higher in 2011 even as growth in the first half came in below forecasts. Consumer prices rose 2.1 percent and 3.4 percent versus real gross domestic product of 2.2 percent and 1.5 percent in the first two quarter of the year, while increasing at a 3.6 percent annual rate in July.

The biggest problem for investors seeking a hedge on a global basis is that large scale inflation protection is only offered through bonds “and bonds are dead,” Sebastien Goldenberg, global head of inflation products in London at Citigroup Inc. said, citing volatility in sovereign bonds.

Bank of America Merrill Lynch’s MOVE index, which measure price swings in Treasuries based on prices of over-the-counter options maturing in two to 30 years, has averaged 99.87 basis points this month, compared with 90 this year.

“If there is in inflation it’s not going to be purely CPI driven, it will look different than anything that happened before,” Roy Niederhoffer, president of New York-based hedge fund R.G. Niederhoffer Capital Management, said. “The global economy is a tremendous unknown, and not an unknown easily influenced by central bankers. We don’t know which outcome it’s going to be, but it will probably mean more volatility.”

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U.S. inflation-protected debt is attractive as the risk that the global economy is returning to recession overtakes concern simulative monetary policies will boost consumer prices, according to RBC Global Asset Management s Gordon Latter. Investors have reduced their...

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