The U.S. is about to sell 10-year inflation-linked debt, keeping the spotlight on a corner of the bond market that’s rarely garnered this much attention in the almost quarter-century since its debut.
Heightened fears about the risk of raging consumer-price gains as growth rebounds are driving investors of all stripes to search for cover in Treasury Inflation-Protected Securities, a market that’s grown to $1.6 trillion. Traders talk of new entrants like retail buyers and global macro strategists -- what the veterans are dubbing the “tourist crowd.” Cash has also been flowing into the largest exchange-traded fund for TIPS, part of the rabid demand that’s driven inflation expectations over the next half-decade to a 16-year high.
It’s all adding up to a head-spinning stretch for inflation traders. They say they’ve been caught off guard by the burst of activity, and the speed with which last year’s pandemic-induced recession is giving way in some minds to 1970s-level angst over out-of-control inflation. Barclays Plc’s Chris McReynolds likens the volatility in TIPS pricing to “watching table tennis while sitting in the middle of the table.”
Leaving aside questions over whether TIPS are overstating inflation pressures, traders see opportunity at a time when forecasts for some key data, including consumer prices, have been way out of line with actual readings. Gang Hu, at hedge fund WinShore Capital Partners, says he’s seen many traders exit TIPS positions over much of this year as market-based inflation expectations climbed. He says Thursday’s $13 billion auction of inflation-linked debt will be seen as a key gauge of investor appetite and a possible opportunity for some to re-enter.
“Nobody actually has a very good handle on where near-term inflation prints will land, and it’s thrown everyone off their game,” said Hu, a managing partner at the New York-based fund. “There’s a lot of noise in the recent prints and this is not over yet. There’s no way anyone can be very confident about what the next two or three prints will bring.”
Fed Test
That’s spurring volatility in a part of the bond market that hasn’t typically seen such activity, with volumes swinging from week to week as above-estimate inflation readings test the Federal Reserve’s oft-repeated message that the pressure is likely to be temporary.
This past week, the five-year inflation outlook, or breakeven rate, jumped to 2.82%, the highest since 2005, after a bigger-than-expected surge in consumer prices for April. The 10-year nominal Treasury yield touched the highest in more than a month this week.
The signals from bonds have broad implications across markets. Stocks slumped by the most since February after the inflation data as traders pulled forward the timing for when they expect the Fed to lift rates, and a measure of consumer sentiment unexpectedly slumped this week. Fear of inflation is also driving a flurry of corporate issuance.
“We’ve obviously been through a lot in this part of the market in the last 14 months -- going from, ‘Wow, this pandemic is deflationary’ to ‘Oops, there’s inflation,’ ” said McReynolds, head of U.S. inflation trading at Barclays in New York. “What’s different in this episode is the crazy volatility, with investors going from hating TIPs to loving them, to hating them again. We are probably going to be here for at least a couple of years,” with volatility elevated around consumer-price data releases.
For much of its existence, the TIPS market has been a largely bearish one -- where traders were skeptical about the sustainability of any substantial price gains that did emerge. The few times that expectations did soar, they always retreated.