TIPS Spread

I have had some private emails discussing the TIPS spread as well as some posts recently dealing with inflation expectations so I thought it might be helpful to post a chart of the TIPS spread to portray what the market is currently expecting in that regards.

The TIPS spread is calculated ( I am using the 10 year ) by essentially subtracting the yield on the 10 year Treasury Inflation Indexed Constant Maturity Security by the yield on the 10 year Treasury Constant Maturity Security. The difference between the two is the market's expectation of the inflation rate over that period.

Here is the chart that I have created using that data.

As you can see, the expectations have risen and fallen since the start of this particular data series. As you look at this chart, you can practically see the shift in sentiment as the market looks for deflation, then looks for inflation, then shifts back to deflation, etc.

What is interesting is to observe this chart starting near the end of May 2013 - beginning of June 2013 and move forward to the present time. Note how the pattern on the chart constricts with the inflation expectation oscillating somewhere between 2.30 on the top and 1.93 on the bottom. Then the range tightens on the downside moving up from a low near 2.06 and rising towards lows near the 2.11% level.  The top has come down somewhat as well.

What this tells us is that the market is reaching an inflection point where this indecision will eventually be resolved. One would think that the resolution would be to the upside if the economy were to begin really improving. I maintain that it is slack in the labor markets that is keeping inflation low as wages remain relatively flat. Thus the Velocity of Money continues to either move lower or remain flat. As long as that is the case, it is difficult to see inflation pick up to any degree of noteworthiness. If however, wages begin to move higher, this would have significant impact on the Velocity of Money as many businesses might begin to feel more comfortable passing along any price increases at the wholesale level. So far, it seems that many are trying to absorb as much of those costs as possible to retain pricing competitiveness among very price-conscious consumers.

Along this line, a strengthening Dollar will generally tend to put pressure on commodity prices.


I do want to also point out that the constricting range in the spread above corresponds very closely to the range trade that we have been seeing in gold. In looking over the price chart for the metal, one can see that same sideways pattern going back to last spring and continuing to the present day.

I am going to fine tune this chart as time permits this week and will overlay the price of gold over it. I think you will find the results rather remarkable. One thing I can already tell you in advance from doing a cursory examination of the two, is that peaks in the price of gold have tended to correspond rather closely to peaks in the TIPS spread.

That would confirm that gold is moving based on inflation expectations or the lack thereof, something which I feel confirms the idea that gold is doing exactly what it ought to be doing during a period of uncertainty in regards to the future of inflation expectations. At the risk of again angering the gold manipulation crowd, if the gold price is moving in sync with the TIPS spread, then asserting that the price is being manipulated is a big stretch as one would have to make the serious case that the inflation expectation of the market place over the last several years has been completely misguided. Given the ( up until recently) rather mediocre at best payrolls numbers, stable to falling commodity prices in general, and a steady US Dollar, that would be a very difficult case to make except for all but the most imaginative.