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US Inflation Bonds Gain Momentum Again

© Fotolia / IrochkaUS investors worry about possible inflation growth in country
US investors worry about possible inflation growth in country - Sputnik International
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Rising housing costs are making US investors worry about possible inflation growth and prompting them to seek inflation protection for the first time in two years by driving cash into specialty funds that focus on Treasury Inflation Protected Securities (TIPS), Reuters reports.

MOSCOW, September 4 (RIA Novosti) — Rising housing costs are making US investors worry about possible inflation growth and prompting them to seek inflation protection for the first time in two years by driving cash into specialty funds that focus on Treasury Inflation Protected Securities (TIPS), Reuters reports.

"TIPS have had a good tail wind this year. We have inflation, as opposed to last year when we had disinflation," said Gemma Wright-Casparius, who oversees Vanguard's $26.3 billion inflation-protected securities fund, as cited by Reuters.

During the course of seven consecutive quarters of outflows, investors drained almost $38 bn from TIPS-focused funds. In the third period, funds have attracted $1.52 bn so far, marking the first quarterly inflows since the third quarter of 2012. Fund managers have said that rising housing costs are outpacing other consumer cost increases, renewing the risk of higher inflation.

According to a Reuters poll of economists, inflation is likely to rise in the coming month. The Consumer Price Index has risen at 2 percent year-over-year for 4 months and is forecast to accelerate to 2.2 percent. The principal of a TIPS bond depends on inflation – when the CPI rises, the principal adjusts upward, making TIPS a sensible choice. In 2013 TIPS suffered their worst decline (8.61 percent) since their introduction in 1997. According to indexes compiled by Barclays, TIPS have produced a return of 6.35 percent since January.

However, economists suggest that the inflation-driven bonds may not be able to sustain their gains. "I think it's going to be much more challenging for them to generate returns as high as they have been in the past year or year to date," said Bill Irving, a Merrimack, New Hampshire, portfolio manager for Fidelity Investments.

The reason is that a significant portion of this year’s TIPS gains have been caused by an unexpected decline in real yields, which are measured against inflation. The real yield on 10-year TIPS fell to 20 basis points recently; short-term real yields do not show positive momentum either. Demand for low-risk sovereign bonds, in the face of conflicts in Ukraine and the Middle East and negative yields in Europe, led to a dramatic rally in bond markets across the globe. That further supported TIPS gains, however the sustainability of the dynamics is not guaranteed.

Despite the mortgage crisis seven years ago and the collapse of the housing market, more Americans have become renters, which is driving up demand for apartments and accelerating the growth of rental costs.

Owners’-equivalent rent, which makes up 31 percent of core CPI, rose 2.9 percent year-over-year in July and a related measure of rent rose 3.2 percent, its fastest rate since March 2009. Some fund managers expect that the trend could accelerate in 2015. "We are looking at shelter inflation in the next 12 to 18 months to touch the high 3 percent, maybe even 4 percent,", said Martin Hegarty, co-head of Blackrock’s global inflation-linked portfolio in New York. "That provides a relative stable base for everything else to build on top of."

There remains the risk that because of limited expected gains in wages, household spending could decline as rent and food prices rise. But these fund managers believe that an underlying measure of wages for private sector production and nonsupervisory employees has been rising at a quick pace and consumers should be prepared for higher costs.

Nevertheless, one signal from the inflation bond market assumes that investors are skeptical about higher wages and price increases. TIPS’ breakeven rates, showing differences between the yields on TIPS and regular Treasuries and gauges of investors’ inflation expectation, have declined since the beginning of the year. Bond managers think that a further fall in breakeven rates would provide investors with higher profits at cheaper levels in the long run.

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