TIPS show inflation alarm fading as options give Fed time

Payer Skew

The Barclays data measures what traders call the payer skew using options on interest-rate swaps. The skew typically widens when traders anticipate a rise in yields as they seek to hedge the value of their holdings. It’s now 25 cents for the shorter term, about unchanged from December, while it’s 89 cents for options that mature in 2015, up from 80 cents at the end of 2011. Each 10 cents represents $100,000 of bonds.

“The options market is pushing expectations of a violent sell off in the Treasury market further into the future,” said Piyush Goyal, a fixed-income strategist in New York at Barclays, in a telephone interview on Sept. 21.

Goyal and his colleagues including Amrut Nashikkar were No. 2 this year in Institutional Investor magazine’s survey of U.S. money managers in the category of best strategists for interest- rate derivatives behind JPMorgan Chase & Co.

Fed Plan

The Fed said Sept. 13 that it would buy $40 billion of mortgage bonds a month until the U.S. sees what Bernanke described as an “ongoing, sustained improvement in the labor market.” The central bank also said it would probably hold the federal funds rate near zero at least through mid-2015. Since January, it had said the rate was likely to stay low at least through late 2014.

Gross, who manages the $272 billion Total Return Fund at Newport Beach, California-based Pacific Investment Management Co., wrote on Twitter the day after the Fed’s announcement that the central bank would “buy mortgages ‘til the cows come home’’ and that investors should ‘‘buy real assets...gold...a house!’’ He wrote on Sept. 18 that ‘‘we are in an age of inflation.’’

While his fund has gained 9.09 percent this year, beating 97 percent of its peers, it lagged behind in 2011 with a 4.16 percent return, underperforming 69 percent of rivals as Gross wrongly bet Treasury yields would rise, data compiled by Bloomberg show. He cut the fund’s holdings of U.S. government bonds last month to the lowest level since October, or 21 percent of assets.

Election Issue

The consumer price index rose 1.7 percent in August. Bond yield have been mostly below the gauge since April 2011, resulting in negative real yields.

The Fed’s actions have become an issue in the U.S. presidential race. Representative Paul Ryan of Wisconsin, the Republican vice-presidential candidate, said Sept. 12 that if Mitt Romney is elected, he would focus on ‘‘sound money” to prevent stagflation, referring to an environment of low growth and high inflation last seen in the 1970s.

Romney and President Barack Obama will debate economic policy Oct. 3 in Denver.

Investors initially increased their inflation expectations on the Fed’s plan. The gap between yields on 10-year notes and same-maturity Treasury Inflation-Protected Securities, or TIPS, widened to 2.73 percentage points on Sept. 17, the highest level since May 2006. The so-called break-even rate, which measures how much traders anticipate consumer prices will rise over the life of the debt, narrowed last week to 2.42 percentage points.

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