Bloomberg News

Sell Treasuries for TIPS as Inflation Bets Rise, Citigroup Says

August 24, 2012

Investors should sell Treasuries and buy inflation-indexed securities, betting expectations for rising prices continue amid speculation the Federal Reserve will add further monetary stimulus, according to Citigroup Inc.

Break-even rates, the yield gap between nominal notes and Treasury Inflation Protected Securities, or TIPS, from one to five years are poised to widen after the Fed signaled this week it’s ready to embark on a third round of asset purchases under quantitative easing, said Jabaz Mathai, an interest-rate strategist at Citigroup. Inflation expectations should increase further, he said, reflecting the 23 percent rise in crude-oil prices since June 28.

“TIPS are cheap to Treasuries given the fact that QE3 remains on the table, and likely, and that the rally in oil hasn’t fully been priced into the TIPS market,” Mathai said in a telephone interview. “There is more widening to come in break-even rates.”

The break-even rate between five-year notes and TIPS has risen to 1.94 percentage points from a low this year off 1.51 percentage points in January.

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 the break-even rate.

Inflation Protection

Demand for inflation protection has pushed an index of TIPS to a 5.4 percent gain this year, according to Bank of America Merrill Lynch Indexes. Conventional Treasuries returned 2 percent.

The Fed’s favored bond-market gauge of inflation expectations was 2.55 percent on Aug. 21, up from 2.38 percent on July 26. The five-year, five-year measure shows how much traders anticipate consumer prices will rise during a period of five years starting in 2017.

Fed Chairman Ben S. Bernanke is scheduled to speak on Aug. 31 at a Kansas City Fed conference in Jackson Hole, Wyoming, where he may clarify his thinking on the need for stimulus.

“There is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery,” Bernanke said in a letter dated Aug. 22 to Representative Darrell Issa, a California Republican who chairs the House Oversight and Government Reform Committee.

Many policy makers said additional stimulus probably will be needed soon unless the economy shows signs of a durable pickup, according to minutes released Aug. 22 of the central bank’s most recent meeting, on July 31-Aug. 1.

The central bank bought $2.3 trillion of debt from 2008 to 2011 in two rounds of a stimulus strategy called quantitative easing.

To contact the reporter on this story: 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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