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Inflation—one of bond investors’ chief enemies—may be making a resurgence. Writes Anthony Valeri, Senior Vice President of Fixed Income Research at LPL Financial.
While the rate of inflation remains low, market awareness about a possible bottom is increasing. This week the Federal Reserve’s preferred measure of inflation—core personal consumption expenditures (PCE)—is expected to increase to 1.4% for April 2014 after a 1.2% annualized rate in March.
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Why should bond investors be concerned about rising inflation? Since most bond interest payments are fixed over the life of the bond, rising inflation can erode the value of those payments and lead to lower bond prices down the road.
However, increases in inflation expectations and in the broad price indexes, such as the CPI, are still modest by historical comparison. Writes Valeri. The 10- year TIPS yield suggests that CPI inflation will average 2.25% over a 10-year horizon—a low level.
Valeri says he believes inflation will increase slowly, but added that current bond yields offer limited protection against rising inflation. “Low real yields present an unattractive investment proposition for bond investors, and renewed weakness in the economy is needed to justify current real yields.” He said.
If inflation creeps toward the Fed’s 2% target over 2014 and into 2015, it suggests the Fed is likely on track to raise rates in late 2015/early 2016. The Fed is projecting a median 1.0% and 2.25% fed funds target rate by year-end 2015 and 2016, respectively, but fed fund futures indicate a 0.6% and 1.6% rate for the same time periods—a significant disparity. Fading rate hike expectations indicate pricing could be as good as it gets for high-quality bonds.
You can read the full article on Business Insider!
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LearnBonds: – What is going on in the bond market? – What is going on in the bond market? The yield on the 10-year Treasury Inflation Protected Securities (TIPS) closed below 20 basis points on Wednesday, May 28. This yield has not been so low since the middle of May in 2013. The yield had actually been lower, but the rate had been so low because of all the money that had gravitated to the United States because of the financial conditions in Europe.
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Bloomberg: – Bond surge worldwide drives index yield to one-year low. – A worldwide bond-market surge pushed yields to the lowest levels in a year on growing evidence central banks can keep stimulating economic growth without igniting inflation.
Yahoo Finance: – Treasury bonds will remain hot as long as recovery remains tepid. – The slowness of the economy to recover from the recession, plus the lack of inflation in the system means that US Treasury yields may remain low for a while longer, says Kirk Barneby, portfolio manager of the Centre Active U.S. Treasury Fund.
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TheStreet: – Want Yield? Stay away from Treasury inflation-protected securities. – Treasury Inflation-Protected Securities, or TIPS, are an interesting subset of Treasury bonds designed to protect your purchasing power from the effects of rising consumer prices. However, many investors have fallen prey to the misconception that rising TIPS prices means an inflationary environment.
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High Yield Bonds
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Gross: PIMCO’s “New Neutral” says FF capped at 2% in 2017 due to high debt & structural headwinds. Bonds OK at these levels.
— PIMCO (@PIMCO) May 28, 2014
The bond market has probably discounted this already but there will be an ugly GDP revision tomorrow.
— Ed Bradford (@Fullcarry) May 28, 2014
Yesterday’s bond rally, on no news, smelled of offside positioning & investors too short. Buying intermediate & long to play catch up.
— AnthonyValeri (@Anthony_Valeri) May 29, 2014