Bloomberg News

U.S. TIPS Demand Wanes as Europe Crisis Pares Inflation Outlook

November 18, 2011

Nov. 17 (Bloomberg) -- The Treasury’s $11 billion auction of 10-year inflation-indexed notes attracted lower-than-forecast demand as Europe’s sovereign debt crisis diminishes investor expectations for rising consumer prices.

The Treasury Inflation Protected Securities, or TIPS, were sold at a yield of 0.99 percent, compared with a forecast of 0.060 percent, the average estimate in a Bloomberg News survey of seven of the Federal Reserve’s 21 primary dealers that are required to bid on U.S. debt auctions. A record low yield of 0.078 percent was set at the Sept. 22 auction of the securities.

Yields on Treasuries fell for a fourth day on concern Europe’s leaders are failing to contain the region’s debt crisis as borrowing costs jumped at Spanish and French bond sales, spurring demand for the safety of U.S. government securities. The cost of living in the U.S. unexpectedly fell 0.1 percent in October from the prior month, the first decline since June, the Labor Department reported yesterday.

“It wasn’t a great auction,” said Michael Pond, co-head of interest-rate strategy in New York at primary dealer Barclays Plc. “There has been a flight to liquidity into nominal Treasuries, and when that happens these auctions can go much worse. There was a 2 basis point tail. It light of the atmosphere, that is acceptable.”

The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered was 2.64, compared with 2.61 at the September sale and an average of 2.79 for the past 10 sales.

‘Looming Question’

Indirect bidders, a class of investors that includes foreign central banks, purchased 46.3 percent of the notes, compared with 30.4 percent of the securities at September’s auction. The average for the past 10 offerings is 41 percent.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 11.6 percent, compared with a record 35.7 percent at the previous sale and an average of 8.2 percent at the past 10 auctions.

“While Europe is still the looming question mark for all markets, it’s a good signal that this market is able to take down this size in an pretty efficient manner,” said Brian Fitzsimmons, a trader at primary dealer Credit Suisse Group AG in New York.

The Treasury in May 2010 added more frequent auctions of TIPS, resulting in six 10-year TIPS sales a year, to improve the liquidity of the securities, whose principal is adjusted to reflect changes in the consumer price index.

Inflation Expectations

TIPS returned 13.68 percent this year, as measured by Bank of America Merrill Lynch indexes, compared with a 8.9 percent gain for the broader Treasury market, the most since the financial crisis in 2008.

Federal Open Market Committee participants on Nov. 2 said inflation, measured by the personal consumption expenditures price index, would rise at a 1.4 percent to 2 percent rate in 2012, according to the central tendency outlook, which excludes the three highest and three lowest projections. They kept their longer-run inflation goal in a range of 1.7 percent to 2 percent.

The Fed’s preferred price measure, which excludes food and fuel, is forecast to rise 0.1 percent in October, after being unchanged the previous month, according to a Bloomberg News Survey of economists. It is forecast to rise 1.7 percent in October from a year earlier, compared with 1.6 percent in September, a report Nov. 23 is forecast to show.

‘Hot-button Issue’

“The Fed can be reasonable comfortable with where inflation is right now,” said Thomas Simons, a government debt economist in New York at primary dealer Jefferies Group Inc. “It doesn’t seem to be getting a lot of focus because the primary hot-button issue is Europe and the implications for a global economic slowdown, which is kind of deflationary.”

Ten-year break-even rates, the difference between yields on 10-year inflation-indexed bonds and nominal Treasuries of the same maturity, touched 1.87 percentage points today, the lowest since Oct. 7. The rate reached a 2011 high of 2.67 percent on April 11 and a low for the year of 1.67 percent on Sept. 23. The breakeven rate represents traders’ expectations for the rate of inflation during the life of the bonds.

The five-year, five-year forward break-even rate, which the Fed uses to help determine interest-rate targets, reached 2.4 percent today, lower than the 2011 average of 2.82 percent. The rate touched a 2011 high of 3.23 percent on Aug. 1 and a 2011 low of 2.09 percent on Sept. 22.

--Editors: Dave Liedtka, Ken Pringle

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Cordell Eddings in New York at ceddings@bloomberg.net

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


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