Bond Traders Are Keeping a Wary Eye on Inflation
(Bloomberg Opinion) -- For all the talk of a looming recession, bond traders aren’t quite ready to declare inflation dead. Yes, various measures of inflation expectations based on bond yields have dropped to their lowest since mid-2017, and even to 2016 in some cases. Traders are hedging their bets nonetheless.
That can be seen in the U.S. government’s auction on Thursday of $13 billion of 10-year Treasury Inflation-Protected Securities. Investors submitted bids for 2.42 times the amount offered, which is in line with the average of 2.51 times over the prior 10 auctions. The Wall Street firms that are obligated to bid were only able to grab 16.6 percent of the issue, the lowest for that maturity since January 2018 (this was the sixth auction since then). The results are all the more remarkable given that the supply of so-called TIPS is forecast to increase by $20 billion to $30 billion this year as the government ramps up borrowing. Then again, many factors besides the outlook for inflation go into the decision to buy TIPS or not, including whether they are cheap relative to conventional bonds. And it’s true that TIPS got beat up last year, with the Bloomberg Barclays Global Inflation-Linked Bond Index falling 4.11 percent last year compared with a decline of 1.20 percent for the Bloomberg Barclays Global Aggregate Bond Index. But while inflation has been muted as the Federal Reserve raised interest rates, suddenly dovish central bankers, who are now advocating a go-slow approach to tighter policy, means that there’s a greater chance of a pickup in inflation.
That can be seen in the longer end of the yield curve because longer maturities tend to get hurt the most when inflation accelerates. The gap between five- and 30-year Treasury yields is about the widest since early 2018, even as the difference in yields between shorter-maturity debt have inverted for the first time in more than a decade. As bond traders know, the time to buy inflation protection is when it’s cheap, which is before inflation starts to accelerate.
THE WAITING IS THE HARDEST PART
An otherwise dull day in in the stock market was suddenly jolted by a report that Trump administration officials are considering measures to roll back tariffs on Chinese products to calm financial markets. The S&P 500 Index rose as much as 1.11 percent but gave up some of those gains after the Treasury Department disputed the report. Trade talks are no doubt critical for equities, but just as important is what happens this earnings season, which is the most anticipated in some time because nobody really knows what to expect. For example, Bank of America charts a measure of Wall Street unanimity it calls analyst clustering that calculates the degree to which profit estimates for individual companies deviate from one another. Bloomberg News’s Lu Wang reports that this measure is right around a record level of tightness at a recent reading of 5.6 percent, below the long-term average of 9.6 percent. While some might see this as a sign of confidence among analysts in that they know what to expect, it could also be seen as a sign that analysts are just looking at what their peers are forecasting and plugging in the same or similar numbers. Either way, volatility is likely to increase as results start to be reported in earnest in coming weeks. While the relative cost of protecting against swings in the broader market has fallen, Wang reports that for the average stock, it’s rising based on data compiled by Goldman Sachs.
POUND TRADERS ARE AN OPTIMISTIC BUNCH
From the outside, the U.K. political scene couldn’t be worse. Prime Minister Theresa May’s plan to leave the European Union was soundly defeated on Tuesday, forcing her to face a vote of no confidence in her government on Wednesday, which she survived. Now she’s back to square one with nobody really sure what happens next or whether the U.K can still negotiate a so-called Brexit that wins lawmakers’ favor. And yet foreign-exchange traders are pretty sanguine. The Bloomberg Pound Index, which measures sterling against a basket of major peers, has risen for five consecutive days to its highest since mid-November. No other major currency has appreciated as much as the pound in that period, according to data compiled by Bloomberg. The currency market is betting that political initiatives are now “likely to lean in the softer Brexit direction, which will favor a ‘buy pound on dips’ strategy,” Alan Ruskin, chief international strategist at Deutsche Bank AG, told Bloomberg News on Wednesday. “But for the pound to push significantly higher, we will need to see signs that Theresa May’s offer to also work with the opposition is gaining some traction.” Given how badly Brexit talks have gone for the U.K. over the past 22 months, that seems like wishful thinking.
TURKEY GIVES ERDOGAN MORE POWER. REALLY.
Turkey granted President Recep Tayyip Erdogan emergency powers that give him broad authority to act when Turkey’s financial stability is deemed to be under threat. Given the collapse in the lira that resulted from prior moves by Erdogan to gain greater control over economic matters, the decision by Parliament seems a bit shortsighted. Nevertheless, Turkey’s Borsa Istanbul 100 Index of equities surged 1.47 percent to its highest since October, far outpacing the meager gain in the MSCI Emerging Markets Index. Parliament voted late Wednesday to authorize Erdogan to take all the necessary measures in case of a “negative development” that could spread across the entire financial system, according to Bloomberg News’s Firat Kozok. It also approved the formation of the Financial Stability and Development Committee, which will work to coordinate efforts against risks to financial stability and security, according to the law, set to go into effect after the president approves it. Long known for his unorthodox view that rate hikes only lead to faster price gains, Erdogan is assuming broader powers ahead of municipal elections in March as the country careens toward its first recession in a decade.
THERE’S ALWAYS A BULL MARKET SOMEWHERE
Nothing seemed to work for investors in 2018. Globally, stocks, bonds and commodities all lost money after taking into account inflation. Even measures of returns for the foreign-exchange market were in the red. But if you happened to be in palladium, you did great, and the metal has picked up right where it left off. The metal has already surged 13.3 percent in January after soaring 14.6 percent in all of 2018. Palladium has benefited from growing political tensions between the U.S. and Russia, one of the top producers of the metal. More broadly, the metal has been supported by consumers turning toward gasoline cars, which tend to use more palladium in autocatalysts, instead of diesel. Even so, the bulls seem to be ignoring some simple facts. Auto sales are weakening globally, according to Bloomberg News’s Rupert Rowling and Marvin G. Perez. “Investors appear to be ignoring the fact that weak sales figures have been reported for all major auto markets in recent days,” Commerzbank analysts wrote in a research note. “Instead, they are seeing news such as the planned widening of a strike to include the platinum mines of a major South African gold and platinum producer as being a good reason to buy.”
There are all sorts of estimates of what is now the longest U.S. government shutdown in history will mean for the economy. And because two-thirds of the economy comes from consumer spending, the monthly University of Michigan Sentiment Index will be closely parsed for clues as to whether Americans are changing their behavior as a result of the shutdown. The median estimate of economists surveyed by Bloomberg is for a reading of 96.8 for January, down from 98.3 in December. Even so, that would only be the lowest level since August. Bloomberg Economics noted that in October 2013 — the most recent prolonged shutdown — overall sentiment dropped 4.3 points before rebounding in the month the government reopened. “Large swings in consumer sentiment due to political uncertainty are not unprecedented,” the team at Bloomberg Economics wrote in a research note. “However, they are usually short-lived and do not ordinarily lead to changes in consumer spending.”
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.
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