Pimco Joins Invesco Finding Value in TIPS

“It’s a good time to seek inflation protection,” Craig Veysey, the head of fixed income at Sanlam Private Investments Ltd. in London, part of the Sanlam Group which oversees $72 billion of assets, said by phone Feb. 12. “Central banks, which for years have been trying to keep inflation at a relatively low level, now understand they need to do much more. I’m not saying inflation is likely to rise sharply. The market has not sufficiently priced in the risk.”

U.S. consumer prices rose 1.6 percent in January from a year earlier, the Labor Department reported Feb. 21. Inflation averaged 2.5 percent over the past decade.

The Treasury sold $9 billion of 30-year TIPS Feb. 21. Indirect bidders, a gauge of demand from overseas buyers, bought 54.5 percent of the issue, the second-biggest share on record going back to 2001, according to data compiled by Bloomberg.

Under Pressure

With economies still failing to shrink debt and grapple with above-average unemployment, growth and inflation are likely to stay subdued, according to Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 21 primary dealers that trade with the Fed. The U.S. economy contracted in the fourth quarter while Japan and the 17-nation euro area extended recessions.

“Break-even rates may come under pressure again if risk appetite falters,” Anton Heese, the global head of inflation strategy at Morgan Stanley in London said by phone on Feb. 13. “My impression is that a lot of investors lack conviction on the recovery we are seeing at present. The output gap in the economy is still substantial. Therefore, there is potential for growth to pick up with inflation remaining subdued.”

The Fed cut its benchmark overnight bank lending rate from 5.25 percent in September 2007 to a record low of zero to 0.25 percent in December 2008. It began buying $1.7 trillion in mortgages, Treasuries and agency debt to encourage new bank lending in 2008, followed by a $600 billion second round of Treasury purchases in November 2010. Operation Twist in September 2011 replaced $667 billion in short-term bonds with longer-maturity issues.

Fed Purchases

The central bank is now buying $85 billion of mortgages and Treasuries each month to underpin the economy and reduce the 7.9 percent unemployment rate. Its balance sheet topped $3 trillion for the first time last month.

Policy makers said in December they would hold interest rates at about zero so long as projected inflation stays at 2.5 percent or less and unemployment remains above 6.5 percent. The jobless rate was 7.9 percent in January, government data show.

Investors should buy TIPS because the Fed’s policies will eventually fuel inflation, according to Bill Gross, co-chief investment officer at Pimco, which runs the world’s biggest bond fund. “We’re not inflationary hawks in 2013. We simply think because central banks are writing trillions of dollars worth of checks, ultimately that will produce the desired inflation they are targeting,” he said in a telephone interview Feb. 22.

International Linkers

Gross said he owns 10-year and 15-year TIPS that reflect inflation expectations for 2020 and 2025, as well as New Zealand and Mexican linkers. He sees U.S. inflation at 2 percent this year and 2.5 percent for the three years after that.

While the Bank of England’s 2 percent inflation target was breached for the 38th consecutive month in January, Governor Mervyn King said Feb. 13 that central bank officials will keep encouraging growth. The latest minutes of its policy meeting, published Feb. 20, said further asset purchases “could help the process of rebalancing the economy.”

The BOE said in July that the 200 billion pounds ($305 billion) spent on bond purchases from March 2009 to January 2010 increased output by as much as 2 percent and inflation by 1.5 percentage point.

In Japan, the central bank raised its inflation target to 2 percent in January from 1 percent. New Prime Minister Shinzo Abe campaigned on promises of more monetary stimulus and weakening the yen, which has dropped 17 percent against the dollar since Oct. 1, its worst performance over a similar period since 1985.

‘Kitchen Sink’

“Central banks have made it even clearer they are not prepared to tolerate anything less than inflation,” Neil Williams, chief economist at Hermes Fund Managers, which oversees $42 billion of assets, said in an interview Feb. 14. “That means they will throw a kitchen sink at it in terms of liquidity injections.”

The value of global equities surged $6.5 trillion since mid-November, with the Standard & Poor’s 500 index reaching a five-year high. The Stoxx Europe 600 Index rose 12 percent since European Central Bank President Mario Draghi pledged July 26 to do “whatever it takes” to safeguard the monetary union.

Several policy makers said the Fed should be ready to vary the pace of monthly bond purchases, according to the minutes of the Federal Open Market Committee’s Jan. 29-30 meeting. They review the program March 19-20.

“The Fed is more tolerant of higher inflation outcomes in order to work on the other side of their mandate” to cut unemployment, Michael Pond, head of global inflation-linked research in New York at primary dealer Barclays Plc, said by phone on Feb. 21. “Inflation-linked securities offer very cheap insurance because if the Fed is going to get it wrong, they are going to get it wrong on the side of leaving accommodation longer rather than risking removing it too early.”

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