No inflation as yields jump belies point of no return view

‘Feel Sorry’

“I feel sorry for people that have clung to fixed-dollar investments,” Warren Buffett, chairman of Berkshire Hathaway Inc., said at the company’s May 4 shareholders meeting in Omaha, Nebraska. Savers depending on bond payments are “victims” of policies to lower borrowing costs, he said.

Fed officials led by Chairman Ben S. Bernanke will trim bond purchases to $65 billion a month at the Oct. 29-30 meeting of the Federal Open Market Committee, from the current level of $85 billion, according to the median estimate in a survey of 59 economists last week. In a similar survey before the central bank’s April 30-May 1 meeting, economists expected it to cut buying to $50 billion in the fourth quarter.

Policy makers remain divided over the next steps for stimulating the world’s biggest economy. Philadelphia Fed President Charles Plosser has called for tapering the bond purchases that have pumped more than $2.8 trillion into the financial system as soon as the central bank’s next meeting on June 18-19.

Fiscal Drag

New York Fed President William C. Dudley said in an interview with Bloomberg News in May he would like to wait three or four months to see “how the tug-of-war between the fiscal drag and the improving economy are going to sort of work their way out.”

Inflation across developed economies rose 1.3% in April, the least since 2009, the Paris-based Organization for Economic Cooperation and Development said June 4. Consumer price rises in May were less than forecast in eight of 10 countries tracked by the Citigroup Inflation Surprise indexes.

Arguing that yields should be higher “would be easier if there were some inflation,” Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said in a June 3 telephone interview.

Consumer prices are being held down in part by the slowest velocity of money in March since at least 1959, according to data compiled by Bloomberg. The gauge measures the rate at which cash changes hands, dividing GDP by the Fed’s M2 measure of money supply.

Break-Even Rate

The gap in yields between TIPS and U.S. government debt not indexed for inflation, known as the break-even rate that shows investor expectations for the consumer price index over the life of the bonds, narrowed last week to 2.15 percentage points, the lowest on a closing basis since July, from 2.59 percentage points on March 14.

Real yields on 10-year Treasuries after subtracting the PCE deflator index, was 1.43% last week, about the highest since April 2011, and up from 0.18 percentage point less than inflation in November.

That’s still too low, according to Donald Ellenberger, who oversees about $10 billion as co-head of government and mortgage-backed securities at Federated Investors in Pittsburgh.

“There’s not enough value yet in Treasury yields to make them a good buy relative to other fixed-income asset classes,” Ellenberger said in a June 5 telephone interview. “Inflation is a lagging indicator” and tends to rise two years after the start of a “normal” recovery.

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