Analysis: Ignoring the Fed on inflation seen a winning bet

NEW YORK Thu Feb 10, 2011 1:15pm EST

Chairman of the Federal Reserve Ben Bernanke testifies on the state of the U.S. economy before the House Budget Committee on Capitol Hill in Washington February 9, 2011. REUTERS/Kevin Lamarque

Chairman of the Federal Reserve Ben Bernanke testifies on the state of the U.S. economy before the House Budget Committee on Capitol Hill in Washington February 9, 2011.

Credit: Reuters/Kevin Lamarque

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NEW YORK (Reuters) - Investors are often told not to fight the Fed, but in the U.S. Treasuries market taking the opposite stance to the Fed has been a winning strategy in the past six months.

While Fed Chairman Ben Bernanke sees no inflation problem, bond investors who expect an economic recovery will lead to prices rising faster have been outperforming their peers.

Mutual funds investing primarily in short-duration Treasury Inflation-Protected Securities (TIPS) have outperformed those who have stuck to longer-term Treasuries, data from Thomson Reuters' Lipper service shows.

"I would argue that in a strange, even ironic way, that Ben Bernanke is doing a good job selling my fund for me these days," said Tom Luster, portfolio manager and director of investment grade fixed income at Eaton Vance in Boston.

"The more the Fed thinks that inflation is not a problem today the more likely it is that inflation becomes a problem in the future," he said.

The average maturity for TIPS is 8.70 years, however six-month returns for TIPS maturing in the 0-5 years range are up 1.198 percent while those maturing in 10 more years are down 2.688 percent, according to Barclays Capital.

Returns for U.S. Treasuries are down 2.186 percent over the same period.

The Eaton Vance short-term real return fund, while less than a year old, is among the top three performers in the last six months, returning 3.37 percent to investors.

But it is not simply that the fund has inflation-protected Treasuries in the portfolio but that the duration is very short, roughly two years. They argue against extending duration as this opens them up, along with everyone else, to interest rate risk from the Fed.

'IT IS ALL ABOUT EXPECTATIONS'

No one expects the Fed to raise rates from their current zero to 0.25 percent range anytime soon given the bigger focus on generating jobs. However, its quantitative easing programs have caused inflation expectations to rise.

"It is all about expectations. The Treasury market has been fading under the rapid rise of stocks. I think people are looking ahead and expecting inflation to be a greater concern, said Jeff Tjornehoj, interim head of Lipper Americas Research.

While benchmark 10-year U.S. Treasuries have suffered an epic drubbing, causing yields to rise 125 basis points in the span of less than five months, the Standard & Poor's 500 index is up 17 percent in the same time.

The latest inflation data shows overall consumer prices rose 0.5 percent in December, however excluding food and energy costs, consumer prices rose just 0.1 percent.

Overall prices are up 1.5 percent in January from a year ago, while core consumer prices gained 0.8 percent in 2010, the slowest calendar year pace since the department started keeping records in 1958.

"Right now we are positioned cautiously against long-term Treasuries," said Kent Burns, portfolio manager at Franklin Templeton fixed income group.

But Burns added he is now less concerned about long-term rates rising as they have already surged considerably.

The firm's real return fund is up 0.92 percent year to date. It is the best performer in the group of 118 funds over a one year time frame with a 7.41 percent return.

Burns said the fund is not as exposed to TIPS but more importantly, similar to Eaton Vance's Luster, duration has been kept very short at just over one year.

TIPS FUNDS ATTRACT $22 BLN

Treasury Inflation-Protected Securities are investments that protect against rising prices. Because they are indexed against inflation, TIPS holders will not see their principal lose value.

Moreover, the Fed and economists monitor the difference between TIPS and Treasury yields as a gauge of investors' inflation outlook.

This "breakeven" rate between 10-year TIPS and 10-year benchmark Treasury yields has risen more than 0.75 percentage points to 2.35 percent on Wednesday after the Fed signaled last August it was open to pursue another bout of large-scale bond purchase to help the economy.

The U.S. central bank at that time was focused on averting a double-dip recession after the European debt crisis caused economic growth to sputter last spring.

So far this year, all Treasury debt has underperformed stocks and other riskier assets on worries over growing inflationary pressure due to faster global growth and surging commodity prices.

But TIPS have fared better than regular counterparts.

Lipper data shows investors have poured $22.35 billion into TIPS funds since the start of 2008. When factoring market prices, assets under management in U.S. domiciled funds has increased to $39.9 billion, a 251 percent increase.

On the opposite end of the spectrum and in performance are funds such as the Wasatch-Hoisington U.S. Treasury fund, which is down 7.36 percent y-t-d and off 12.39 percent in the last six months.

Lacy Hunt, the chief economist at Hoisington Management in Austin, Texas, says the Fed's quantitative easing policies are creating short-term gains but are really counter productive for the economy.

"In reality much of what the Federal Reserve has done has been to increase the income of the wealth divide rather than provide a net benefit," he said, citing the commodity price inflation that is costing the median U.S. household an extra $1,300 in food and fuel.

"But they have raised short-term inflationary expectations which have been a detriment to the Treasury bond market and to our fund," he said.

(Additional reporting by Richard Leong)

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Comments (1)
Soothsayer wrote:
What a crock. Food is up much higher: apples that were $1.29 a year ago are $1.49; domestic beer has skyrocketed from $5.79 per half case to $9 plus; milk is up 15%; gasoline is up from $2.62 to over $3; my house insurance is up 20% over one year and 191% since 2005; a loaf of bread is up 20%; ice cream, chips, bleach, and most other everyday household products have seen both smaller packaging (on the order of 25%) and price increases; thanks to mergers and acquisitions, banks aren’t paying people interest, airlines are gouging customers, commodities prices are rising, and we all know about the oil companies. Now we have a merger on the horizon with the NYSE, I’m sure we’ll all get reamed somehow when that occurs. I expect in the next decade that we will see automobile manufacturers merge, I’m sure that we won’t benefit when the FTC fails its duty and blesses those when they come. Does the government think we don’t notice the blatant lies?

Feb 10, 2011 1:50pm EST  --  Report as abuse
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