Investors May Be Underestimating Pace of Inflation (Update2)
By Walden Siew
New York, July 12 (Bloomberg) -- Investors may be underestimating the threat of inflation.
With the economy rebounding and commodities prices rising, inflation is likely to pick up speed later this year, making Treasury Inflation Protected Securities, or TIPS, a good buy, some analysts said.
``Re-acceleration in the economy is imminent and inflation is about as good as it gets,'' said Richard Berner, chief economist at Morgan Stanley. ``The Fed's not changing monetary policy any time soon and the global economy's recovering. This adds up to inflation going in the other direction.''
Ten-year TIPS, whose yield is reset twice a year based on the consumer price index, yield 2.99 percent, 1.67 percentage points less than the 10-year Treasury note. The gap, which was as much as 2.2 percentage points earlier this year, signals misplaced ``complacency'' about inflation, Berner said.
Economists expect U.S. gross domestic product increased at a 2.5 percent annual rate in the second quarter, a Bloomberg News survey showed. The pace is down from a 6.1 percent growth rate during the first quarter that many economists said was unsustainable.
Inflation has remained tame during the rebound from the recession that began in March 2001. The consumer price index, which increased to 1.2 percent on a year-over-year basis in May from 1.1 percent in January, is still about a third of its year- ago level.
Defense
That rate may double by next year, with CPI climbing to a 2.5 percent year-over-year rate, said William Tedford, who helps oversee $500 million in fixed-income securities at Stephens Capital Management in Little Rock, Arkansas. Tedford boosted TIPS holdings to 35 percent of his total portfolio from 25 percent.
``An increase in inflation and rising interest rates'' are ahead, Tedford said. ``We're starting to get ready by creeping into a defensive posture.''
The strength of the U.S. economic rebound may be tempered as consumer confidence wanes. U.S. consumer confidence fell the most since the Sept. 11 terrorists attacks, according to a University of Michigan survey for July, as slumping stock prices and rising unemployment threatened to slow the recovery.
The university's preliminary index of consumer sentiment sank to 86.5, a seven-month low, from 92.4 in June. The index had dropped almost 10 points in September.
Wholesale Prices
The 10-year inflation-linked Treasury has returned 6.3 percent so far this year including reinvested interest, more than any other benchmark Treasury note.
Commodity prices hint of faster inflation to come. A global recovery in manufacturing has lifted industrial commodity prices, according to economists at Chicago-based Northern Trust Corp.
Higher prices for items including cars, apparel and cosmetics contributed to an increase in inflation at the wholesale level, excluding food and energy, the firm said. The index for semi- finished goods, such as processed foods, parts and components, rose 0.2 percent, pushing the six-month annualized increase to 1.5 percent, compared with a 1.6 percent decline last year, according to a Northern Trust research report yesterday.
The Labor Department next week is expected to say the CPI rose 0.1 percent in June, with the core index, which excludes food and energy, up 0.2 percent, according to a Bloomberg News survey of economists.
Not Worrisome
As long as companies have to absorb higher raw-material costs and have no ability to raise prices of goods they sell, inflation will remain a non-issue, some investors said. The narrowing gap between TIPS and regular Treasuries is confirmation that inflation isn't an issue and the Federal Reserve will act quickly to raise rates should it begin to accelerate, they said.
``I don't see inflationary pressures and companies don't have any pricing power as far as raising prices on a consumer level,'' said Kevin McNair, who helps oversee $17 billion at BB&T Asset Management in Raleigh, North Carolina. He said inflation will climb toward 3 percent in 2003. ``We're not busting out from recession.''
Inflation hasn't been a concern for investors for most of the past decade, as the consumer price index hasn't climbed more than 4 percent during the period. The index rose 6.3 percent in 1990.
McNair bought inflation-linked debt a year ago and kept holdings of the securities at less than 5 percent, about half the recommendation of the Merrill Lynch & Co. bond index he tracks.
Skepticism
Investors should shift all their fixed-income investments into inflation-linked debt to protect capital against rising interest rates, Banc of America Securities LLC strategist Thomas McManus said last month. He had recommended keeping two-thirds of bond investments in inflation-protected securities.
Treasury inflation-indexed securities were introduced in 1997. This year, Peter Fisher, Treasury undersecretary for domestic finance, said the government will stick with TIPS, calling them ``an efficient financing instrument'' for the government. He eliminated the 30-year TIPS in October at the same time he suspended sales of the 30-year Treasury bond.
While trading of all Treasury securities exceeds $300 billion daily among the 22 firms that do business with the Fed, TIPS trading accounts for less than 1 percent of the total, according to New York Fed statistics. That may change as signs of inflation increase, some analysts said.
``Investors are gaining a healthy dose of skepticism and they're looking for quality and bulletproof portfolios,'' said John Brynjolfsson, who helps oversee more than $5 billion in TIPS for Newport Beach, California-based Pacific Investment Management Co.'s Real Return Fund.
The fund added more than $1 billion in new investments and capital gains during the second quarter, he said.
``We're seeing huge interest in TIPS,'' Brynjolfsson said. |
