Bloomberg News

Morgan Stanley Sticks With Call for Higher Inflation: Tom Keene

June 30, 2011

June 30 (Bloomberg) -- Gregory Peters, head of global fixed-income economic research at Morgan Stanley, said the operator of the world’s largest brokerage continues to expect inflation to rise over the next year.

Oil prices slid, easing market-based gauges of inflation expectations, after the Paris-based International Energy Agency announced on June 23 the release of 60 million barrels of oil over 30 days from member nations’ emergency stockpiles as fighting in Libya pares global supplies. Oil futures fell 4.6 percent on the day the announcement was made.

“The IEA’s surprise announcement is temporary and you are seeing that getting re-priced already,” Peters said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “It’s more of a temporary phenomenon than anything else and we still think inflation is on the rise.”

Bloomberg News reported yesterday that Morgan Stanley was burned by a wager on U.S. inflation expectations in the second quarter, citing three people informed of the dealings. The bank’s interest-rates trading group lost at least tens of millions of dollars on the trade, two of the people said, declining to be identified because the transaction isn’t public. Mary Claire Delaney, a Morgan Stanley spokeswoman, declined to comment.

Traders at the bank bet that inflation expectations for the next five years would rise in Treasury markets, while forecasts for the next 30 years would fall, according to two of the people. Such wagers on so-called break-even rates involve paired purchases and short sales of Treasuries and Treasury Inflation Protected Securities, or TIPS, in both maturities.

Consumer Price Index

“That is not really my area of expertise and there has obviously been a lot of negative press,” Peters said, referring to the New York-based firm’s forecast for rates in the TIPS market. “We still believe that inflation is on the rise.”

The consumer-price index increased 0.2 percent in May, compared with the 0.1 percent median forecast of economists surveyed by Bloomberg News, figures from the Labor Department showed on June 15. The so-called core measure, which excludes more volatile food and energy costs, climbed 0.3 percent.

Brent oil for August settlement fell 18 cents to $112.22 a barrel today. The European benchmark has fallen 3.5 percent in June. It traded today at a premium of $17.18 to New York-traded West Texas Intermediate. Crude oil in New York added 0.1 percent to $94.88 a barrel.

TIPS Payments

The decline in crude oil prices disproportionately hurt the value of TIPS maturing within five years because they have fewer remaining interest payments that can benefit from a rebound in prices. The five-year break-even rate dropped to as low as 1.76 percentage points this month on June 24 from 2.04 percentage points at the end of May, indicating underperformance by five- year TIPS relative to nominal Treasuries. The rate increased to 2.04 points today.

Despite some softer-than-expected U.S. economic data, “you’ve seen a steady rise in both core and headline inflation,” Peters said. “We see that continuing throughout the course of this year, abating somewhat next year.”

U.S. employers in May added the fewest workers in eight months and unemployment unexpectedly rose to 9.1 percent, underscoring the concern of policy makers that the expansion is failing to boost the labor market. The Federal Reserve today completed its second round of asset purchases, known as QE2, after buying $1.7 trillion in securities through last year, increasing the amount of money in circulation. The Fed bought $600 billion in Treasuries in the most recent program.

The Fed has kept its target rate for overnight lending between banks at a record low range of zero to 0.25 percent since December 2008.

--Editors: Dave Liedtka, Dennis Fitzgerald

To contact the reporters on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net; Tom Keene in New York at tkeene@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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