Treasury auction shows inflation concerns

 U.S. inflation-indexed bonds are outperforming Treasuries as investors seek a hedge against the risk of higher consumer prices.

Today’s $13 billion auction of 10-year Treasury Inflation Protected Securities attracted the highest demand in two years, including record purchases from a category of bidders that includes foreign central banks. The surge in demand pushed the gap between yields on fixed-rate Treasuries up the most in a month. The notes were sold at a yield of 0.339 percent.

“It speaks to the slowly more pervasive view that inflation might be turning the corner,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, one of 22 primary dealers that bid at the auction. “The strength was surprising given how low real yields are.”

The difference between yields on 10-year notes(CBOT:TYM14) and same- maturity TIPS, a gauge of trader expectations for consumer prices over the life of the debt known as the break-even rate, jumped to 2.22 percentage points, from as low as 2.17. The average for the past decade is 2.21 percentage points.

Conventional U.S. 10-year note yields rose two basis points, or 0.02 percentage point, to 2.56 percent at 1:35 p.m. New York time, based on Bloomberg Bond Trader data. Earlier they climbed to 2.57 percent, the highest since May 14.

TIPS have returned 5 percent in 2014, versus 3 percent for conventional securities, according to Bank of America Merrill Lynch indexes.

Biggest Loss

Exchange-traded funds tracking U.S. inflation have seen inflows of $129 million this month, the first since March, according to data compiled by Bloomberg.

TIPS lost 9.4 percent last year as the broad Treasuries market declined 3.4 percent amid a rally in higher-risk assets. It was the inflation-linked securities’ second annual loss since being introduced in 1997 and their worst ever, according to Bank of America Merrill Lynch’s U.S. Inflation-Linked Treasury Index.

Investors submitted bids for 2.91 times the amount of debt offered, the most since the sale in May 2012. The average for the past 10 sales is 2.51.

The Treasury said it will auction $108 billion in notes next week: $31 billion in two-year debt, $35 billion in five- year securities, $29 billion in seven-years and $13 billion in two-year floating-rate notes.

CPI Increases

The annualized U.S. consumer price index rose in April by 2 percent, the most since July, a Labor Department report showed on May 15. It was up 1.5 percent the prior month.

The Fed’s target for annual inflation is 2 percent. Its preferred gauge, the personal consumption expenditures index, has remained below the goal for almost two years. The measure increased 1.1 percent in March from a year earlier.

The central bank is scaling back the bond-buying program it has used to pump money into the economy amid signs growth is accelerating. It has expanded its balance sheet to more than $4.3 trillion since 2008 in bond purchases designed to lower longer-term borrowing costs, fueling concern the strategy would spur inflation. The Fed also has held the benchmark interest rate at virtually zero since 2008.

Fed policy makers are watching progress toward their goal of full employment as they consider the timing of the first interest-rate increase since 2006.

Fed Meeting

Minutes released yesterday of the Fed’s April meeting showed officials said continued stimulus to push unemployment lower doesn’t risk sparking an undesirable jump in the inflation rate.

Commodities have gained this year, with the Standard & Poor’s GSCI gauge of raw materials advancing 4.1 percent, as the S&P 500 Index of stocks rose 2.2 percent.

Treasuries fell today as the National Association of Realtors reported that closings on previously owned U.S. homes increased 1.3 percent to a 4.65 million annual rate. Economists surveyed by Bloomberg projected a 4.69 million pace. The number of homes for sale jumped 16.8 percent in April.

Treasuries trading is scheduled to close tomorrow at 2 p.m. in New York and stay shut worldwide on May 26 for Memorial Day in the U.S. and the Spring Bank Holiday in the U.K., according to the Securities Industry and Financial Markets Association.


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