The iShares TIPS Bond ETF (NYSEArca: TIP) is down 7% from its all-time high with rising Treasury yields and falling inflation combining to weigh on the $12 billion exchange traded fund. The sell-off in the inflation-indexed bond ETF could be a bullish signal for equities and a negative indicator for gold and other safe-haven assets, analysts say.
For the first time since 2009, U.S. bond yields are rising at the same time inflation is slowing, Bloomberg News reports. Meanwhile, the yield spread between TIPS and regular Treasury bonds reveals investors have cut their expectations for consumer price increases to the lowest level since July.
Rising Treasury yields and falling inflation expectations are poison for TIPS.
TIPS values are linked to changes in the Consumer Price Index but the bonds are also sensitive to interest rates like normal Treasuries. So TIPS can lose value when Treasury yields rise.
The CPI fell 0.4% in April from the previous month on lower gas prices. For the 12 months that ended in April, overall prices rose 1.1%, the smallest annual gain in two and a half years, according to the Associated Press.
Bloomberg reports that the last time yields rose while inflation slowed was four years ago, following President Barack Obama’s $787 billion stimulus plan. Also, the so-called breakeven rate between TIPS and Treasuries last week narrowed to the lowest since July.
The breakeven rate is determined by comparing the yields of regulator government bonds against inflation-protected securities of the same durations. If inflation averages more than the breakeven rate over a given time period, then investors would be better off owning TIPS than normal Treasury bonds.
On Monday, yields on 10-year TIPS turned positive for the first time since January 2012, reports Ben Eisen for MarketWatch.
Next page: It’s different this time
“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.