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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: CalculatedRisk who wrote (67043)	7/29/2006 1:37:23 AM
From: mishedlo	Read Replies (2) \| Respond to of 110194

Thanks Too bad it does not go back to 1980 Nonetheless I see little correlation between that chart and the price of gold. I see no correlation whatsoever between the price of gold and the 30 yr long bond since 1980. since gold is not is not tracking those what is it tracking? The only thing that I can see that it is tracking is the K-Cycle that suggests gold will get smashed in disinflation (which we had for 20 years or so), then rally into deflation. Of course we have not have deflation yet, but we did have one doozie of a "false spring". Gold did respond to the liquidity surge (interest rates cut to 1%) but so did everything else. One can not cherry pick the last 3 years ignoring 23 years and say there is some sort of corelation between gold and treasuries or "inflation expectations". Mish

To: CalculatedRisk who wrote (67043)	7/31/2006 8:52:02 AM
From: shades	Read Replies (1) \| Respond to of 110194

TIPS Prove A Complicated Inflation Predictor . By Michael S. Derby A DOW JONES NEWSWIRES COLUMN NEW YORK (Dow Jones)--Over the last several years, Federal Reserve officials have placed an ever greater emphasis on controlling expectations of inflation, arguing that if one keeps those forces in check, it helps keep actual price pressures from flaring up. The problem is, it's always been an imprecise effort to properly gauge what market and public expectations are. Policy makers reach their conclusions based on a mix of factors. But one tool they rely on most frequently is the Treasury's inflation indexed bonds, better known as TIPS. The policy makers, along with market participants, rely on something called the "break even" spread: the difference between the yield on bonds the government adjusts for changes in inflation, relative to regular cash bonds. When the difference between TIPS and cash Treasury grows wider, it's believed that's a signal investors see more inflation coming. Recently, central bankers have pointed to the pricing levels of TIPS to bolster arguments that a recent rise in actual inflation is unlikely to persist, given that breakeven spreads have remained well behaved. But new research from Federal Reserve Bank of Kansas economist Pu Shen, published in the bank's Second Quarter Economic Review, says that in reality TIPS may not be as reliable an indicator as they have been made out to be due to the difference in liquidity between the two markets. Many have long recognized that while the cash Treasury market is perhaps the most easily traded in the world, buying or selling a TIPS security has generally been a tougher thing to do, and yields in that market are higher to compensate for that challenge. "Liquidity differences between nominal and inflation indexed Treasurys have been nontrivial," Shen wrote. "Simply attributing changes in yield spreads to changes in market inflation expectations and ignoring the liquidity risk premium could lead to overstated inflation expectations," he added. The paper took a look at TIPS yields versus cash Treasurys and surveys of economists' inflation expectations between 1999 and 2006, and found a troubled performance for inflation indexed securities. It noted that yield spreads "were mostly well below" the expected inflation rate of forecasters shown in the Blue Chip Economic Indicators Poll and the Survey of Professional Forecasters. Moreover, the Blue Chip survey actually proved most reliable in predicting the real five year average inflation rate. Yield spreads "were mostly well below" actual inflation rates, the paper said. Shen reckons yield spreads' under-prediction of inflation resulted from the fact that "the liquidity risk premia in the yields of the TIPS were larger than the inflation risk premia" shown by conventional Treasurys, hence the wrong signal emanating from the security's pricing levels. To arrive at the inflation risk premium, the liquidity premium is be deducted from the yield spread - which resulted in the understatement. Shen reckons investors would have likely been aware of liquidity issue, but "it may surprise other market observers...who tend to consider the liquidity risk premium to be of secondary importance to the inflation risk premium." Things appear to have improved in recent years. "From 1999 to 2003 the liquidity risk premium was consistently larger than the inflation risk premium," Shen wrote. But "as the TIPS market has deepened, the liquidity premium has generally declined" and this could well continue, the economist wrote. But that's added another wrinkle: after 2004 yield spreads were "mostly above" economists' survey forecasts of expected inflation. While this could be a function of a change in the market's inflation bet, "a more plausible explanation is that at least part of the changes was caused by decreases in liquidity risk premia in TIPS," Shen concluded. Ultimately, "taking account of the liquidity risk premium greatly complicates the task of extracting information from the yield spreads about market inflation expectations," Shen wrote. The Kansas City Fed paper can be found on the bank's website at kansascityfed.org. (Michael S. Derby, a special writer with Dow Jones Newswires, has covered the Federal Reserve since 2001. He also writes about bond markets and the economy.) -Michael S. Derby, Dow Jones Newswires; 201-938-4192; michael.derby@dowjones.com (END) Dow Jones Newswires July 31, 2006 08:32 ET (12:32 GMT)