"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Saturday, May 11, 2013

TIPS SPREAD - Inflation Expectations still Subdued

Those who regularly read this site will know that the last two days' worth of action in the interest rate markets has piqued my interest. I am still unclear on what the rather sharp rise means and whether it is just movement tied to currency market volatility or it is a reflection of something else.

I have gone over to look at the TIPS spread to see if there is any pattern or development there that warrants further attention.

Thus far I do not see anything of note. There is no spike higher indicating a shift towards inflation worries in the market at this point even though yields have risen.

As you can see, back during the depths of the credit crisis, when deflation fears were at their peak, the spread collapsed almost to zero. That meant that the market had basically ruled out any chance whatsoever of the least bit of inflation.

Since the Fed has gotten involved with the QE programs, the spread has moved up towards 2.5 and then dropped off as the various QE programs ran their course and expired (You can see where the inflation expectation falls below 2% when the market feared the impact of a QE cessation). As each new QE program was announced, the market built back inflation expectations between 2.0 - 2.5% or so. Currently we are looking at an expected inflation rate by the market of 2.3% as of Friday this week.

It seems to me that the Fed is using this indicator as a means of determining whether or not its policies are having the appropriate impact on investor sentiment. Based on what I can see of this spread, those Dovish Fed governors who are expressing concerns about inflation not being high enough do not really have much to justify their concerns.

I think we would have to see the spread move below 1.75% to give their view any credence. I would think that if the market believes the economy is strong enough on its own to no longer need any QE efforts, talk of ending that program would not move this spread to narrow significantly. In the past, when those programs expired, the market moved back towards expecting deflationary pressures to begin reasserting themselves.

The flip side to this is the ceiling on this spread. Since the beginning of 2008, the spread has not exceeded 2.64%. Anytime it has run up above 2.5% it has not lasted long even with all the massive QE. It just goes to show you that in spite of the enormous sums of money that have been created through the QE programs, it has barely been sufficient to offset the debt that was being extinguished. Inflation expectations have not been nurtured in spite of it all.

AT what point this changes is unclear but once this spread were to ever exceed that 2.64 - 2.65% level we would know without a shadow of a doubt what the market was thinking in regards to inflation. I still believe that at some point we are going to have to pay the piper for all this massive money creation; I am just not sure about the timing of it all.

Let's keep an eye on this spread to see if we can get any advance warnings of when that just might be.


  1. When the equity market has a big sell-off, money will rush into Treasuries pushing the yields lower.

    The insiders who have hints of these actions can make serious cash off the backs of the investing public.

  2. "I am still unclear on what the rather sharp rise means and whether it is just movement tied to currency market volatility or it is a reflection of something else."

    It is because of THIS.

  3. Dan, there could be a different explanation than just inflation/deflation...

    09/2010 "The House of Representatives on Wednesday passed legislation to pressure China to let its currency rise faster, fanning the flames of a long-running dispute over trade and jobs" (Reuters) From this moment the spread goes UP.

    05/2011 "China’s yuan strengthened beyond 6.5 per dollar for the first time since 1993, supported by speculation the central bank will allow appreciation to help tame the fastest inflation in more than two years.

    The currency’s seventh weekly gain, its longest winning streak since July 2008, may damp U.S. criticism of China’s exchange-rate policy before Vice Premier Wang Qishan heads to Washington next month for talks with Treasury Secretary Tim Geithner." (Bloomberg) From this moment the spread goes DOWN

  4. 10/2011 "After years of trying, Congress is taking another stab at retaliating against what many see as Chinese manipulation of its currency to make its exports to the United States cheaper and U.S. exports more expensive" (Fox News)

    "A U.S. bill to pressure China into letting its currency rise in value, which has drawn warnings from Beijing of a possible trade war, ran into opposition from the top Republican in Congress.
    On Monday, the Senate voted to open debate on a bill that calls for U.S. tariffs on imports from countries with deliberately undervalued currencies, prompting an angry rebuke from China" (Reuters) From this moment the spread goes UP

    04/2012: "China took a milestone step in turning the yuan into a global currency on Saturday by doubling the size of its trading band against the dollar, pushing through a crucial reform that further liberalizes its nascent financial markets." (Reuters) From this moment the spread goes DOWN.

    07/2012: "Congressman Bill Owens renewed his call today for the House to pass legislation forcing China to play by the rules of fair trade to help the American private sector create jobs. Owens’ call comes on the heels of a report by the Wall Street Journal this week that detailed the People’s Bank of China guiding the Chinese currency to “its weakest level of the year.” Overall, the Wall Street Journal reports, the Yuan has fallen 1.1% against the dollar this year." (Bill Owens website) From this moment the spread goes UP

    09-11/2012 The spread spikes during the pre-US elections. Candidates are on the opposite side when it comes to China (Republican are FOR a strong reaction against China and its "manipulation of the yuan while Obama is for a low profile reaction (as he did during the 4 previous years). After the election's result and Obama's victory the spread goes DOWN again.

    I can find only ONE explanation to the above correlation:

    When the USA (through its clowns in Congress) attacks China for its "manipulation" of its currency, the possibility of China reacting by dropping the US dollar is increased. The only option for the US, in order to reduce the fall of the USD would be to increase interest rates...and the spread goes UP.

    When China becomes more accommodative (floating of the yuan) the risk of a currency war disappears and the spread goes DOWN. HOWEVER this was OK as long as China was still ready to support the USD or at least make sure it won't go down too fast. It is my opinion that the rules have changed when in May 2, 2013 China PBOC decided to fixe record high midpoint to guide yuan higher. "The point of confusion in the market is largely related not to whether the yuan should be as strong as it is, but why the PBOC is allowing it to appreciate so quickly, after leashing it for so long. The midpoint rate has strengthened by 773 points so far in 2013, around five times its net gain for all of 2012." (Reuters)It is my opinion that China has finally decided to go after the USD. We could see a flight to safety (and search for higher return) into the yuan and an outflow of money from the USD towards the yuan. If this is true, the higher yield on the 10 year would be just the beginning of the end of the USD and the US economy.

    Does this make sense?

  5. This comment has been removed by the author.

  6. Dan - Could the Fed be buying TIPS as a part of their QE program in order to suppress TIPS from being an indicator of inflation?

  7. Dan - Can you please explain me what do you mean for TIPS spread?

    1. TIPS: "A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed. Interest on TIPS is paid semiannually. TIPS can be purchased directly from the government through the TreasuryDirect system in $100 increments with a minimum investment of $100 and are available with 5-, 10-, and 20-year maturities. (investopedia.com)

      The spread is between these TIPS and regular Treasury bonds. The higher the spread the more likely inflation is going to go up.

      My previous comment about the possible connection between China and the higher spread is because if China decides to go after the USD (pushing the USD lower by pushing the yuan higher through higher trading band for the currency) you will get what Jim Sinclair calls "currency induced push-cost (hyper)inflation". prices will rise not due to more demand, but due to a debased currency that buys less. This is why investors would push the spread higher expecting a large fall of the USD.

      Again this is just an opinion. Dan, any comment on this opinion?


    2. Andrea - Hubert;

      Hubert has summed it up perfectly!

      About the US Dollar - right now, against the other majors - the dollar is strong. I think we are some years away from China's Yuan replacing the US Dollar as the reserve currency. Most likely we will see a basket of currencies functioning as the reserve currency although I am unsure when that might occur.

      One thing that we do know however - China will act whenever they feel it is advantageous for them to do so.

    3. Dan,
      It is still interesting to note that the spread rise started exactly when China announced it is allowing the yuan to appreciate faster.

      It is said that the market "sees" the future 6 months in advance... USD should go dramatically down during the fall of 2013. Will see but knowing how patient and calculating the chess player (China) is I would not be surprised to see this happening.

      Dan as you said: "let's keep an eye on this spread"

  8. Once again, overlay a chart of the U.S. budget deficit vs. the 10-yr. Treasury Yield over the last 20 years and you will see the most eye-popping financial chart ever presented.

    Basically, we have been able to "Print to Prosperity" with no penalty whatsoever, as the faster we print, the faster bond yields fall.

    It is another cog in Bernanke's "Perpetual Motion Machine", whereby weak economic growth spooks investors into bonds, and that same weak growth causes the government to raise even more debt for the EBT cardholders and the millions on phony disability payments.

    Ergo, consumer spending rockets higher, speculators find near zero interest rates irresistable, and buy even more stocks.

    If the Hilsenrath rumor proves to be true and ES falls to 1,400, then bond yields will instantly crash from today's 1.9% to 1.3% in a matter of weeks and start the perpetual motion cycle all over again.

    Bernanke's regime and his successful recruitment of Draghi and Abe have set the stage for more of the same for the next 100 years.

    Due to the wildly successful scheme they created, any and all financial crisis, blowups, or accidents will be fought the same way: Print more money, jawbone down inflation, and voila!!! Every rising stock prices and wealth creation.

  9. Is it really risk free wealth creation?
    Are you wealthier? I'm not.

  10. There is lot of articles on the web about this. But I like yours more, although i found one that’s more descriptive.
    Commodity Tips


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