Jun

28

Attached chart of TIP/TLT (Inflation-indexed bond etf / 20Y bond etf) shows recent roll-over in the wrong (deflationary) direction for those seeking easier repayment of debts and waving of flags over tracts of appreciating houses.

OTOH it is a good direction for those seeking more stimulus and associated nest-feathers.

Kim Zussman refines his views:

A friend, Sam Humbert,  pointed out that TIP and TLT differ in duration (~3.7 yr vs ~20). So to better isolate on inflation, here is a chart of TIP/SHY (SHY= 1-3yr Treasury bond ETF).

The recent move for TIP/SHY is up; opposite to TIP/TLT, showing a significant yield-curve-change component is affecting the former chart. I conclude that the market is more concerned recently about inflation at a 3 year horizon.

Rocky Humbert comments:

The current inflation "breakeven" for 5 Year TIPS versus 5 Year T's is 1.56%.

The current inflation "breakeven" for 10 Year TIPS versus 10 Year T's is 1.91%.

This is the least worst measure of of "investor inflation expectations."

It's important to recognize that TIPS funds (and secondary market TIPS) have a variety of complex technical and tax nuances that make apples-to-apples comparisons with straight Treasuries difficult or misleading.

For example, a taxable buyer of seasoned TIPS who experiences deflation followed by inflation can have a strikingly different total return than a buyer of seasoned TIPS who experiences inflation followed by deflation. This path dependency does not occur in regular Treasuries.

And if one is really clever, one can try to understand the WIP etf … which is based on the DB Global ex-US Inflation Linked Index….
 

Al comments:

I must fight the war against my own ignorance here: What is a "seasoned" TIP?

Rocky Humbert responds:

Asking a question is not a sign of ignorance. It's a sign of wisdom.

A seasoned TIP is both a delicacy at my local steakhouse, and it's an inflation-linked bond that's been trading in the secondary market for a while. The TIP's par amount increases by a CPI factor (when the CPI is positive), and the par amount decreases by a CPI factor (when the CPI is negative).

So, for back-of-the-envelope purposes, if you invest $1mm in a particular TIP bond after it's been through a few years of inflation, and then you hold it through a few years of deflation, it's theoretically possible to lose money even if you hold it to maturity. An analogous extreme example would be if you buy a mortgage-backed security in the secondary market with a 6% coupon and a price of 108 … and the homeowner(s) unexpectedly refinance … and you suddenly get 100 back….losing 8 points.
 

Easan Katir pleads:

The country has had so many years, decades, of rewarding borrowers and spenders through creeping inflation. How about at least a few years for the ones who have scrimped and saved, are unleveraged and tired of paying more for everything every year for most of one's lifetime. Deflation is wonderful. Everything is on sale.

Nick White writes:

That is, of course, until you lose your job because your employers has gone bankrupt from falling prices…. ;-)  

Stefan Jovanovich comments:

Neither deflation nor inflation is wonderful because both are founded in dishonesties; their prices are not set by ongoing enterprise and competition but by government clipping of the coinage, political favors and the sheriff's auction. Easan exaggerates the rewards gained by the borrowers and spenders here in the Golden State. Most of the people in California who used their houses as ATMs did so because their after-tax incomes never recovered from the dot.com bust (unless, of course, they worked for the state or the schools.) There were great frauds committed on mortgage applications and by brokers, appraisers and mortgage lenders; but those were minor costs compared to the major fraud of having the GSEs become one-way hedge funds who agreed with the people chasing housing prices that no one ever lost money buying real estate. (The frauds at the retail level would never have been possible but for the demand from Wall Street. Without the credit bubble there would never have been a housing bubble.)

How about we all try a monetary/tax system that favors neither the borrower nor the lender? Prices would still fall; they always do in competitive markets because the buyers keep their eyes out for ways to get a better deal and the sellers work hard to produce things and services better, cheaper and faster. Nick is right; what makes "deflations" ruinous is not the steady decline in nominal prices that results from constant competition but the collapse that comes from a cascade of credit defaults that reduces commerce to a race to the courthouse.

In 1930 "everybody knew" that the solution to the problem was for the government to bring back the WW I boom by spending money. Mellon tried to argue against such stimulus. He did not say that the solution was to "liquidate, liquidate, liquidate"; what he did tell Hoover was that adding government borrowings to an economy already worried about private credit risks would call the soundness of monetary system itself in question. He was right, of course; that is why Hoover never forgave him and Roosevelt literally persecuted him. Once again, Gresham wins the day; sensible advice, like hard money, is never rewarded in a modern political economy.


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