Pimco Inflation Outlook Proves Prescient as TIPS Beat S&P 500

(Bloomberg) -- Pacific Investment Management Co. has been recommending Treasury Inflation Protected Securities all year, and the call is paying off.

TIPS have returned 7.4 percent in 2016, versus 4.5 percent for nominal Treasuries, Bank of America Corp. data show. They even beat the 6.6 percent return for the S&P 500 Index, including reinvested dividends. The figures have intensified the debate on whether the Federal Reserve can achieve its 2 percent inflation target, after failing to meet the goal for the past four years.

“Inflation is arguably coming off a very depressed level,” said Ben Alexander, one of the principals at Ardea Investment Management Pty in Sydney, which has $4.7 billion in assets including inflation-linked bonds. “The forces driving the low-inflation phenomenon are still intact.”

The yield on U.S. benchmark 10-year notes fell one basis point, or 0.01 percentage point, to 1.74 percent as of 10:48 a.m. in New York, according to Bloomberg Bond Trader data. The price of the 1.5 percent security due in August 2026 was 97 26/32.

Pimco, which runs the world’s biggest actively run bond fund, started 2016 by recommending TIPS, a continuation of a long-standing view, and it repeated the call as recently as last month. Jeffrey Gundlach, the chief investment officer at DoubleLine Capital LP, also said in September that TIPS were becoming more attractive.

Inflation expectations worldwide have jumped to the highest since May 2015. Investors anticipate consumer prices will rise 1.4 percent annually, based on Bank of America Corp. data. The figure is derived by comparing yields on nominal government securities to those on inflation-linked debt.

Yellen’s View

Fed Chair Janet Yellen discussed letting U.S. growth heat up in a speech this month, indicating a willingness to continue stoking prices. Crude oil has climbed past $50 a barrel, almost doubling since February, helping support forecasts that consumer costs will increase.

It’s not a sure thing U.S. consumer prices will keep rising, said Hideaki Kuriki, a bond portfolio manager at Sumitomo Mitsui Trust Asset Management in Tokyo, which has $77 billion in assets.

“In the short term, TIPS are attractive,” he said. “Inflation pressure is not so strong. The Chinese economy is temporarily going up. In the long term, it will slow down. Demand for commodities will not go up.”

CIBC World Markets Japan Inc. in Tokyo says the outlook for U.S. inflation makes nominal Treasuries unattractive.

The difference between yields on 10-year notes and similar-maturity TIPS, a gauge of trader expectations for consumer prices over the life of the debt, rose above 1.70 percentage points this week for the first time since May. Given the current 10-year yield, it means the notes only pay about five basis points after accounting for consumer prices, according to Kazuaki Oh’E, head of fixed income.

“I don’t want to buy here,” he said.

(An earlier version of the story corrected to show that inflation expectation was the highest since 2015.)

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