Conclusion: Real time data is continuing to suggest to us that inflation is set to accelerate, making inflation protection, via TIPS, a compelling addition to our Virtual Portfolio against the backdrop of rising inflationary pressures.
Position: Long Treasury Inflation Protection via the iShares Barclays TIPS Bond Fund ETF.
While Keynesian economics continues to support the resolve of Western officials to perpetuate short-term asset inflation, we continue to highlight the tax on growth that is rising consumer and producer price inflation, as well as accelerating inflation expectations. The price of crude oil remains a real-time quote for the taxation of global fixed capital formation, industrial production, and consumption.
Looking to the U.S. fixed income markets specifically, inflation expectations are indeed accelerating. The 5yr Breakeven Inflation Rates are being priced at 2.03%, up from +1.55% at the start of the year. This +24bps increase since the FOMC’s decision to extend “exceptionally low levels of the federal funds rate at least through 2014” on JAN 25 outpaces the +1bps move in the 27 days following Jackson Hole 2010. As such, on a relative basis, long-term inflation expectations are rising fairly rapidly.
Looking to nominal Treasury yields, both 2s and 10s are testing our intermediate-term TREND-lines of resistance. Just as we concluded in 1Q11, we contend these are not signals for accelerating economic demand, but rather a signal that bond market may be starting to price in this marginal shift in the outlook for the real returns of Treasury yields.
We tend to view inflation differently than the government measure of CPI, which has been altered a bevy of times in the past 20yrs (we believe this is done by design to limit Social Security cost-of-living adjustments). From our perspective, the best measure of actual inflation, as experienced by the consumer, is the spread between headline consumer price inflation and nominal wage growth. That is: what consumers have to spend versus what they earn.
On this measure, JAN ’12 registered as the first sequential acceleration since SEP ’11. In particular, that’s an explicitly negative data point for the 15.1% of Americans living in poverty, as officially defined by the Census Bureau. Accelerating headline inflation disproportionately impacts the lower end of the socioeconomic spectrum, as outlays for food and energy typically garner a higher share of that consumer's wallet.
All told, we continue to see the need for hedging our Virtual Portfolio against upside inflation risks, given the updated economic policies of the current U.S. administration and appointed officials. Our quantitative risk management levels on the TIP ETF are included in the chart below.