No escape for US Treasury inflation-protected securities (TIPS) in first quarter 2019

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The US Federal Reserve’s switch to a more accommodative stance has driven down yields of 10-year US  Treasuries and pushed 10-year breakeven inflation (BEI) rates wider.

In the last quarter of 2018, investor concerns about the combination of moderating global growth data and the FOMC’s (Federal Open Market Committee) apparent determination to keep tightening monetary policy led to a sudden tightening of financial conditions, as equities fell sharply and credit spreads widened.

From early October, equities came under pressure, retreating by 10% from their highs, seemingly on concerns about softening global growth, moderating commodity prices and tightening financial conditions. In late December, poor signalling from the Federal Reserve (Fed) prompted further selling of risk assets, taking US equities into a 20% decline.

The US TIPS[1] market was not left untouched. Breakeven inflation (BEI) rates tend to have a positive correlation to the performance of risk assets (such as equities or corporate spreads), positive correlation with energy, and negative correlation to measures of volatility. Correspondingly, the 10-year BEI narrowed sharply from 2.15% in early October to a low of 1.68% by early January.

At the same time, the onset of negative carry arising from a mix of Consumer Price Index (CPI) seasonality and tumbling oil prices meant that front-dated BEIs underperformed BEIs at longer maturities. On the TIPS yield curve, this was reflected in a 5-year/30-year real yield flattening move.

In mid-January, risk assets turned, as the Fed adjusted its communication. Having indicated on 19 December that it would proceed with “some further gradual adjustment” in policy rates, in January the FOMC removed that phrase from the statement, and indicated that it would remain on hold.

At its March meeting, the FOMC members then lowered their rate projections. In addition, several senior policymakers indicated that the Fed was likely to overhaul its policy framework in the coming months to counter a decline in inflation expectations.

The switch to a more accommodative stance helped drive 10-year US Treasury yields below 2.40%, which in turn helped widen 10-year BEIs back out to 1.90%. At the same time, the prospect of policy rates staying “lower for longer” drove TIPS real yields lower, while simultaneously steepening the nominal yield curve.

Exhibit 1: 10-year and 5-year 5-year forward TIPS BEIs

No escape for US TIPS fed

Source: Bloomberg, 8 April 2019

Exhibit 2: 10-year and 5-year 5-year forward TIPS Yields

No escape for US TIPS fed

Source: Bloomberg, 8 April 2019

[1] Treasury inflation-protected Securities

This is an extract from the Q1 2019 Inflation-Linked Bonds Outlook published in March. To read the full version, click here >

For more articles by Cedric Scholtes, click here >

For more articles by Jenny Yiu, click here >

For more articles on the Fed, click here >

Cedric Scholtes

Co-Head Inflation, Rates Committee Chair, BNP Paribas Asset Management

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