Pacific Investment Management Co.’s forecast for quickening inflation is starting to pay off in the bond market, in contrast with warnings from the Federal Reserve that consumer prices will be slow to pick up.
Treasury Inflation Protected Securities have returned 0.8 percent in the past month, while conventional Treasuries stagnated, based on Bank of America Merrill Lynch indexes. Inflation bonds are reviving after they lagged behind the broader market in each of the past three years.
Pimco has been warning all year that costs are poised to increase. “We expect inflation to rise modestly,” Mihir P. Worah, one of the two managers for the $10.7 billion Pimco Real Return Fund, said in a video on the company’s website last week. Worah, who is based in Newport Beach, California, recommended TIPS on Bloomberg Television in January.
The outlook for consumer prices will guide Fed policy makers, who indicated in December they’d raise interest rates four times in 2016. They stood pat in January, saying inflation is expected to stay low in part because of falling energy prices. New York Fed Bank William Dudley said this week that while he expects inflation to reach the central bank’s 2 percent target over time, he’s less sure now. “I am somewhat less confident,” he said.
The probability the central bank will increase rates this year has risen to about 66 percent from as low as 11 percent in February, according to data compiled by Bloomberg based on fed fund futures.
Treasuries were little changed Thursday, with the benchmark 10-year note yield at 1.86 percent as of 6:57 a.m. New York time, according to Bloomberg Bond Trader data. The price of the 1.625 percent security due in February 2026 was 97 29/32.
Elsewhere in Asia and the Pacific, Australian 10-year bond yields jumped 20 basis points over two days, the biggest back-to-back increase since June, to 2.56 percent. Japanese 20-, 30- and 40-year yields all fell to records.
A flight to quality that sent investors rushing to conventional Treasuries earlier this year is easing, and the focus is returning to the economy, where the latest data are showing improvement from manufacturing to employment.
The Fed’s preferred inflation gauge climbed to 1.3 percent in January, the highest level since October 2014, government figures last week showed. It has been below the target since 2012.
U.S. employers hired 195,000 workers in February, after adding 151,000 in January, based on a Bloomberg survey of economists before the government’s monthly employment report on Friday.
Consumer prices probably aren’t about to take off, said Hajime Nagata, a bond investor in Tokyo for Diam Co., which manages $151.9 billion. “Even though inflation expectations aren’t as low as in mid-February, inflation will be less than 2 percent,” he said. He’s betting a rally in nominal Treasuries has further to go in 2016, he said.
The 10-year break-even rate, which is derived from the difference in yield between conventional Treasuries and inflation-linked debt, climbed to as high as 1.53 percent Thursday, the most in seven weeks. The gauge, which shows what traders expect inflation to average during the period, dropped to 1.12 percent last month, the least since the U.S. was in a recession in 2009.
At Pimco, the Real Return Fund has gained 1.7 percent in 2016, lagging behind the majority of its competitors, based on data compiled by Bloomberg. It has returned 2.3 percent annually on average over the past five years, beating 79 percent of its peers.