Pimco Warns and Warns on Inflation as Bonds Hint It’s Not So Bad

(Bloomberg) -- Pimco keeps warning there’s a U.S. inflation risk. The bond market is signaling there’s no cause for alarm.

Consumer price growth reached the highest since 2012 at 2.5 percent. Yet 30-year U.S. bonds are beating the rest of the market this year, a sign investors expect costs to be held in check. And demand ebbed this week at a sale of 30-year Treasury Inflation Protected Securities.

Yet the divergence highlights a debate over whether the latest jump in inflation is for real. Federal Reserve Chair Janet Yellen said this week that costs moved up mainly because of the diminishing effects of earlier declines in energy and import prices.

“Core inflation is stable,’’ said Hideaki Kuriki, a debt investor in Tokyo at Sumitomo Mitsui Trust Asset Management Co. ”U.S. Treasuries are attractive.’’

U.S. core consumer costs are rising at a 2.3 percent pace. The price index for personal consumption expenditures, another gauge the central bank monitors, is at 1.6 percent.

Another sign that the market isn’t worried about inflation -- futures show better than 50 percent odds the Fed holds interest rates next month and that traders are skeptical the central bank will meet its own projection for three increases by year-end.

“It’s much more likely that we get a big upside surprise in inflation,’’ said Joachim Fels, the global economic adviser for Pacific Investment Management Co. in Newport Beach, California. “The market is not fully priced for that rise in inflation,’’ he said this week on Bloomberg Television.

Pimco has been repeating its warning and recommending TIPS for all of this year and 2016, and it has been a winning call.

TIPS have returned 4.1 percent over the past 12 months, versus a 1.7 percent loss for nominal Treasuries, according to the Bloomberg Barclays bond indexes.

Yet this year’s trading suggests investors are sanguine on inflation. Look at the difference between two- and 30-year yields. The spread has narrowed to 184 basis points from above 200 soon after the Nov. 8 U.S. election, as longer-maturity bonds outperformed. That’s well below the five-year average of 250.

The message for Fed policy makers? They can wait before raising interest rates.

“They think that they’ll be able to hike three times,’’ said Mark Cabana, the head of U.S. short rates strategy at Bank of America Merrill Lynch in New York. “The market thinks that they’ll be able to go twice. More often than not, the market has been right,” he said Thursday on Bloomberg TV.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

To contact the editors responsible for this story: Garfield Reynolds at greynolds1@bloomberg.net, Tan Hwee Ann