Inflation Expectations Rising, But Still Low: TIPS Attractive

Inflation Expectations Rising, But Still Low: TIPS Attractive
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Inflation Expectations Rising, But Still Low: TIPS Attractive

In early 2016, renewed fears about China’s slowing growth and historically low oil prices further pressured the market’s already tepid inflation expectations. Inflation expectations, as proxied by 10-year breakeven inflation (BEI), are measured by the yield differential between like-maturity nominal and inflation-linked Treasuries. The chart shows BEI from 2010 through 31 March.

Since falling to a low of 1.20% in February, BEI has rallied on the back of rebounding oil prices, higher core U.S. prices and a dovish tone from the Fed at its March meeting. Even after this increase, BEI is still well below the 10-year average and the Federal Reserve’s inflation target.

The time to buy inflation protection is before inflation starts to climb. In PIMCO’s view, the market is still underestimating inflation, which creates a compelling opportunity for investors to access what we believe to be underpriced inflation protection via U.S. Treasury Inflation-Protected Securities (TIPS), especially relative to nominal Treasuries.

Some investors considering TIPS may be concerned about real yields, which are now close to 0% for 10-year maturities. However, we note that low real yields are embodied in every asset class and are not specific to TIPS. We see these real yields as attractive compared with the negative real yields in most of the developed world.

For more analysis of trends shaping the economic outlook and their investment implications, please read the latest Putting Markets in Perspective.

Disclosures

Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.