“Normally when yields rise, inflation expectations tend to rise at the same time,” Anton Heese, global head of inflation research at Morgan Stanley, told Bloomberg. “The difference this time is that the market seems to suggest through the price action that we might get a recovery with moderate or no real increase in inflation.”
“Disinflation in the U.S. may not signal economic weakness,” Boost Research said in a note Monday. “Based on the current risk sentiment in financial markets, the low inflationary environment is being interpreted as positive for equities and negative for bonds. This outlook may mean further gloom lies ahead for safe haven asset classes, including gold.”
The disinflationary environment has triggered a sell-off in TIPS, which have posted solid performance the past two calendar years. Inflation-indexed bonds saw similar corrections in late 2010 and late 2008.
The difference in the TIPS pullback this time is that deflation worries in the U.S. have not been accompanied by economic weakness or slumping oil prices, according to Boost Research.
Treasury yields are rising but the poor performance of TIPS suggests investors are not overly concerned about inflation. Meanwhile, stocks are rising and bond prices are falling in spite of benign inflation. Of course, the big wild card is the Fed and the future of its bond-buying program.
“Risk sentiment is anything but downbeat. As we enter the summer season, equity markets may continue to lose some of their momentum,” Boost added. “Yet, against the larger macro backdrop, the greatest downside risk may continue to be within safe haven asset classes, particularly gold.”
Indeed, Ed Yardeni at Yardeni Research points out that TIPS and gold have shown a high degree of correlation in recent years.
iShares TIPS Bond ETF
Full disclosure: Tom Lydon’s clients own TIP.