Investors Continue to Scoop Up TIPS

By Min Zeng 

The retreat of inflation hasn't killed investors' appetite for bonds that protect against rising price levels.

Investors this month have snapped up U.S. Treasury inflation-protected securities, or TIPS, at the fastest pace in 27 months. TIPS help holders hedge against inflation by boosting principal repayments once inflation breaches a certain threshold.

Traders and analysts say the surge of investor interest is surprising because market-based measures of inflation expectations have tumbled to the lowest level in more than four years. Inflation has been quiescent in the U.S. for years and has become more so lately with the plunge of crude oil prices.

Yet buyers contend that the surge is well timed, following a monthslong selloff in TIPS that many bond investors believe has turned the asset class into a bargain. The shift underscores the booming demand from around the world for safe investments at a time of uneven economic growth.

A $16 billion sale of five-year TIPS on Thursday drew the strongest foreign demand since the U.S. started selling the debt in 1997.

"TIPS are extremely cheap," which present a buying opportunity, said Mihir Worah, chief investment officer on real return and asset allocation at Pacific Investment Management Co., which has $1.87 trillion assets under management.

The yield on the benchmark 10-year TIPS was 0.485% Friday, up from this year's low of 0.154% in August. When bond yields rise, their prices fall. The yield was 0.762% at the end of 2013.

Mutual funds and exchange-traded funds focusing on TIPS attracted $266.9 million new cash for the week ending Wednesday, the most on a weekly basis since September 2012, according to data from fund tracker Lipper.

The inflow snapped two weeks of outflows and reduced this year's net cash outflow to $2.6 billion.

Analysts said a rising dollar has continued to attract foreign investors into U.S. financial markets because they can get a pickup in returns from the currency side. The dollar has rallied over 10% against both the euro and the yen this year.

The question is whether buyers are making a wise choice in paying for inflation protection they may not need.

TIPS have posted a total return--including price changes and interest payments--of 3.39% in 2014 through Thursday, according to data from Barclays PLC.

TIPS have lagged behind regular Treasury bonds which have returned 4.8% this year through Thursday.

The yield on the benchmark 10-year Treasury note was 2.178% Friday, down from 3% at the start of January.

Mr. Worah expects oil prices to "rise modestly from here" and said the recent selloff in TIPS has priced in gloomy outlook on inflation.

Other investors, though, are less sanguine. A prolonged decline in crude oil prices would send both inflation indicators and inflation expectations lower further in 2015, they said.

On Friday, the yield premium an investor obtains by buying the benchmark 10-year Treasury note instead of a 10-year TIPS was 1.693 percentage point.

That suggested investors expect the U.S. inflation to be running at an annual rate of 1.693% on average within a decade, below 2% Fed officials consider as appropriate for price stability for the economy.

The premium tumbled to 1.637 percentage point on Monday, the lowest since September 2010. The premium was 2.26 percentage points at the end of 2013.

"There is still no inflation in sight and that's bad for TIPS," said Jeff Tjornehoj, head of Lipper Americas Research.

Write to Min Zeng at [e-mail]

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