Future inflation fears topple TIPS - Eric Janszen

[icm63]

Re: Future inflation fears topple TIPS - Eric Janszen

ALSO ..

I want to subscribe again, I want to by EJ a beer ? This is the best god dam forum on the web.

Have a nice day.

[metalman]

Re: Future inflation fears topple TIPS - Eric Janszen

ALSO ..

I want to subscribe again, I want to by EJ a beer ? This is the best god dam forum on the web.

Have a nice day.

ej's pretty good but it's the cast of characters he's collected that's what really impresses me.

just ran across this from 2006... posted it elsewhere. creepily accurate so far...

Although the U.S. economy maintained its rapid growth during most of the 1990s and 2000s, it was progressively undermined by fiscal mismanagement and a resulting sharp deterioration of the investment climate. The GDP grew about 4 percent annually during the administrations of President Bill Clinton (1993-2001) and during that of his successor, President George W. Bush (2001-2009), except for a brief recession following the collapse of the stock market bubble in 2000. But asset prices fluctuated wildly during the decade, with booms and busts in the stock, bond and real estate markets.

Fiscal profligacy combined with the 2008 oil shock exacerbated inflation and upset the balance of payments. The balance of payments disequilibrium became unmanageable as capital flight intensified, forcing the government in 2008 to devalue the dollar by 30 percent.

Although a bubble in bond and real estate prices from 2001 to 2006 allowed a temporary recovery, the windfall from sales of financial assets to foreign central banks also allowed continuation of the Bush administration's destructive fiscal policies. In the mid-1980s, the U.S. went from being a net exporter of goods and to a significant importer. Sales of financial assets became the economy's most dynamic growth sector. Net foreign purchases of U.S. financial assets grew from 50% of issuance in 1996 to nearly 80% in 2005. Rising foreign borrowing allowed the government to continue its expansionary fiscal policy. Between 2001 and 2006, the economy grew more than 4 percent annually, as the government spent heavily on the military and the real estate and financial sectors provided more than 50% of private sector employment.

This renewed growth rested on shaky foundations. The United States' external indebtedness mounted, and the dollar became increasingly overvalued, hurting exports in the late 2000s and forcing a second dollar devaluation in 2010. The action effectively ended the U.S. dollar's status as a reserve currency. The portion of import categories subject to controls rose from 10 percent of the total in 2008 to 24 percent in 2010. The government raised tariffs concurrently to shield domestic producers from foreign competition, further hampering the modernization and competitiveness of U.S. industry. As unemployment rose to more than 20%, government policies to limit immigration fueled further increases in wage rates and inflation.

The macroeconomic policies of the 2000s left the U.S. economy highly vulnerable to external conditions. These turned sharply against the U.S. in the late 2000s, and caused the worst recession since the 1930s. By mid-2010, the U.S. was beset by rising oil prices, higher world interest rates, rising inflation, a chronically overvalued dollar, and a deteriorating balance of payments that spurred massive capital flight. This disequilibrium, along with the virtual disappearance of the U.S. international reserves--by the end of 2010 they were insufficient to cover three weeks' imports--forced the government to devalue the dollar three times during 2012. The devaluation further fueled inflation and prevented short-term recovery. The devaluations depressed real wages and increased the private sector's burden in servicing its dollar-denominated debt. Interest payments on long-term debt alone were equal to 28 percent of export revenue. Cut off from additional credit, the government declared an involuntary moratorium on debt payments in August 2013, and the following month it announced the nationalization of the U.S. private banking system.

- Face of Inflation: Does the U.S. Have a "Peso Problem" (April 9, 2006)

[ocelotl]

Re: Future inflation fears topple TIPS - Eric Janszen

ej's pretty good but it's the cast of characters he's collected that's what really impresses me.

just ran across this from 2006... posted it elsewhere. creepily accurate so far...

Although the U.S. economy maintained its rapid growth during most of the 1990s and 2000s, it was progressively undermined by fiscal mismanagement and a resulting sharp deterioration of the investment climate. The GDP grew about 4 percent annually during the administrations of President Bill Clinton (1993-2001) and during that of his successor, President George W. Bush (2001-2009), except for a brief recession following the collapse of the stock market bubble in 2000. But asset prices fluctuated wildly during the decade, with booms and busts in the stock, bond and real estate markets.

Fiscal profligacy combined with the 2008 oil shock exacerbated inflation and upset the balance of payments. The balance of payments disequilibrium became unmanageable as capital flight intensified, forcing the government in 2008 to devalue the dollar by 30 percent.

Although a bubble in bond and real estate prices from 2001 to 2006 allowed a temporary recovery, the windfall from sales of financial assets to foreign central banks also allowed continuation of the Bush administration's destructive fiscal policies. In the mid-1980s, the U.S. went from being a net exporter of goods and to a significant importer. Sales of financial assets became the economy's most dynamic growth sector. Net foreign purchases of U.S. financial assets grew from 50% of issuance in 1996 to nearly 80% in 2005. Rising foreign borrowing allowed the government to continue its expansionary fiscal policy. Between 2001 and 2006, the economy grew more than 4 percent annually, as the government spent heavily on the military and the real estate and financial sectors provided more than 50% of private sector employment.

This renewed growth rested on shaky foundations. The United States' external indebtedness mounted, and the dollar became increasingly overvalued, hurting exports in the late 2000s and forcing a second dollar devaluation in 2010. The action effectively ended the U.S. dollar's status as a reserve currency. The portion of import categories subject to controls rose from 10 percent of the total in 2008 to 24 percent in 2010. The government raised tariffs concurrently to shield domestic producers from foreign competition, further hampering the modernization and competitiveness of U.S. industry. As unemployment rose to more than 20%, government policies to limit immigration fueled further increases in wage rates and inflation.

The macroeconomic policies of the 2000s left the U.S. economy highly vulnerable to external conditions. These turned sharply against the U.S. in the late 2000s, and caused the worst recession since the 1930s. By mid-2010, the U.S. was beset by rising oil prices, higher world interest rates, rising inflation, a chronically overvalued dollar, and a deteriorating balance of payments that spurred massive capital flight. This disequilibrium, along with the virtual disappearance of the U.S. international reserves--by the end of 2010 they were insufficient to cover three weeks' imports--forced the government to devalue the dollar three times during 2012. The devaluation further fueled inflation and prevented short-term recovery. The devaluations depressed real wages and increased the private sector's burden in servicing its dollar-denominated debt. Interest payments on long-term debt alone were equal to 28 percent of export revenue. Cut off from additional credit, the government declared an involuntary moratorium on debt payments in August 2013, and the following month it announced the nationalization of the U.S. private banking system.

- Face of Inflation: Does the U.S. Have a "Peso Problem" (April 9, 2006)

Remembering that thread and the way it developed here, I'm not sure if the US is in a situation similar to what it was here in México in 1981-2 or 1994... As posted there, US has both conditions together: Large amounts of debt, both external (1982) and internal (1994). I do remember that Bart has proved that world situation rhymes with that of 1973, but these two dates related to Mexico mark turning points that had to happen due to the previous conditions.

I'm working on an article about points of this, just will let you see one of the base graphs.

[metalman]

Re: Future inflation fears topple TIPS - Eric Janszen

Remembering that thread and the way it developed here, I'm not sure if the US is in a situation similar to what it was here in México in 1981-2 or 1994... As posted there, US has both conditions together: Large amounts of debt, both external (1982) and internal (1994). I do remember that Bart has proved that world situation rhymes with that of 1973, but these two dates related to Mexico mark turning points that had to happen due to the previous conditions.

I'm working on an article about points of this, just will let you see one of the base graphs.

nice. usa is looking 1983... shit didn't really hit the fan for mexico until 5 yrs after the first phase. take time, these processes do.

[ocelotl]

Re: Future inflation fears topple TIPS - Eric Janszen

nice. usa is looking 1983... shit didn't really hit the fan for mexico until 5 yrs after the first phase. take time, these processes do.

Have you noted the main corner points on my graphs?

- Jan 1973. Beginning of the oil crisis
- June 1976. Devaluation from 12.50 to 22 MXP to the USD
- Jan 1982. Begining of the External debt crisis due to lack of reserves, also North-South conference in Cancun
- September 1982. Nationalization of Banks.
- September 1985. 8.1 Earthquake dismantled communications and disrupted economic activity in south central Mexico.
- February 1988. Beginning of the PECE results
- December 1994. Internal debt crisis due to lack of reserves.
- June 1995. Effect of the bailout on the mexican peso.

Also had to make the INPC graph logarithmic, due to 4 decimal points shift between 1950´s and 2000's.

[GeraldRiggs]

Re: Future inflation fears topple TIPS - Eric Janszen

@metalman

thanks for the reminder of that post on the "peso problem"

if this thing comes true and it looks preety good right now, how will the US devalue the currency and won't that make pm's go up in value instantly?

[metalman]

Re: Future inflation fears topple TIPS - Eric Janszen

@metalman

thanks for the reminder of that post on the "peso problem"

if this thing comes true and it looks preety good right now, how will the US devalue the currency and won't that make pm's go up in value instantly?

looks that way!!!

[FRED]

Re: Future inflation fears topple TIPS - Eric Janszen

TIPS toppled! No wonder the Treasury was discouraging us from buying TIPS back in early September. A perfect time to buy.

[goadam1]

Re: Future inflation fears topple TIPS - Eric Janszen

So, is either tips or vipsx a viable inflation hedge?

[Andreuccio]

Re: Future inflation fears topple TIPS - Eric Janszen

TIPS toppled! No wonder the Treasury was discouraging us from buying TIPS back in early September. A perfect time to buy.

I don't get it. As I said on another thread, I owned a mutual fund which is invested in 80% tips: FINPX, fidelity inflation-protected bonds. In early September it was trading at about $11.30. I sold Mid-October at about $10.40. It closed today at $9.94.

There's a chart here:

http://finance.yahoo.com/echarts?s=F...FINPX;range=3m

Here's the first couple of sentences of the Overview on their webpage:

Primarily invests at least 80% of its assets in inflation-protected debt securities of all types and maturities, primarily U.S. dollar-denominated issues with a current focus on U.S. Treasury inflation-protected securities. Investments may also include inflation-protected debt of U.S. Government agencies and instrumentalities and of other entities, such as corporations and foreign governments, as well as non-inflation-protected debt and related instruments.

Granted, it's not exactly like investing in TIPS, but it should be pretty close, shouldn't it?

How was early September the perfect time to buy?

[jk]

Re: Future inflation fears topple TIPS - Eric Janszen

How was early September the perfect time to buy?

it wasn't. it was the perfect time to sell. fred just got a little mixed up- happens to all of us once in a while. [there's another thread - '4,3,2,1..deflation' - in which this is dissected]

otoh- we have the question: is NOW is the perfect to buy?

[Finster]

Re: Future inflation fears topple TIPS - Eric Janszen

it wasn't. it was the perfect time to sell. fred just got a little mixed up- happens to all of us once in a while. [there's another thread - '4,3,2,1..deflation' - in which this is dissected]

otoh- we have the question: is NOW is the perfect to buy?

If you are generally a fan of TIPS and have been looking for a good time to buy, maybe this is it. They're down, at least! And PIMCO thinks they're a bargain.

Note the if's of course. TIPS. I do not like them, Sam I Am. Just for starters, they're marketed as "Inflation Protected" - but they are not. They're indexed to the CPI, which is not the same thing as inflation. EJ discusses this above. For another thing, like other investments, it is nominal returns that are taxed, not real returns, which means you can easily wind up with a negative after tax return, hardly befitting an ostensibly inflation-protected investment.

Suppose, for example, inflation (and the CPI, by some chance) runs 5%. You earn 7% nominal return, about 2% real. If you pay tax at 30%, it's 2.1% of your investment, leaving you with a nominal after tax return of 4.9%. But since inflation was 5%, that means your actual return was -0.1%.

Looked at another way, your real tax rate was in excess of 100%.

Or another, since you trailed inflation, you were not "inflation protected"!

[Guest]

Re: Future inflation fears topple TIPS - Eric Janszen

JK - Was not clarified in that thread whether the only thing worth noting about the TIPS was their premium changes re.long bonds, rather than noting that their yield has netted out (via premium shrinkage to long bonds) quite efficiently after several months to reflect a higher inflation perception. So when TIPS yields change via this repricing, and the direction of those changes is described here being merely a "premium shift" relative to long bonds, that might inadvertently give the impression that TIPS are not talking straight to the changing interest rate environment themselves. If they have come through this past year's market transition to produce a higher yield via repricing themselves then regardless of the finer points of "relativity shifts" and the like, indicating temporary deflation fears, it seems their primary evolution has been a quite coherent response to the same rising rates environment which 30 year mortgages are responding to. That was my understanding of Fred's reference. That TIPS yields and 30 year mortgage rates have each wound up repricing inflation quite coherently to each other.

it wasn't. it was the perfect time to sell. fred just got a little mixed up- happens to all of us once in a while. [there's another thread - '4,3,2,1..deflation' - in which this is dissected]

otoh- we have the question: is NOW is the perfect to buy?

[EJ]

Re: Future inflation fears topple TIPS - Eric Janszen

If you are generally a fan of TIPS and have been looking for a good time to buy, maybe this is it. They're down, at least! And PIMCO thinks they're a bargain.

Note the if's of course. TIPS. I do not like them, Sam I Am. Just for starters, they're marketed as "Inflation Protected" - but they are not. They're indexed to the CPI, which is not the same thing as inflation. EJ discusses this above. For another thing, like other investments, it is nominal returns that are taxed, not real returns, which means you can easily wind up with a negative after tax return, hardly befitting an ostensibly inflation-protected investment.

Suppose, for example, inflation (and the CPI, by some chance) runs 5%. You earn 7% nominal return, about 2% real. If you pay tax at 30%, it's 2.1% of your investment, leaving you with a nominal after tax return of 4.9%. But since inflation was 5%, that means your actual return was -0.1%.

Looked at another way, your real tax rate was in excess of 100%.

Or another, since you trailed inflation, you were not "inflation protected"!

Finster,

Regarding the recent spike in TIPS yields, the conclusion that the huge negative increase in the spread between TIPS and bonds yields is due to a rise in deflation expectations makes sense when the two are in equilibrium via arbitrage but clearly today they are not. Some as-yet unknown factor that is distorting TIPS prices.

A research paper by the St. Louis Fed The Information Content of Treasury Inflation-Indexed Securities in a section titled "Distortions in TIIS Yields and TIIS-Based Indicators" is relevant.

There are several likely differences between the level of TIIS yields and hypothetical ex ante real interest rates that complicate their use as financial indicators. The first two factors cited below should increase TIIS yields relative to the hypothetical default riskfree ex ante real interest rate, while the third and fourth factors can work in either direction, depending on the particular circumstances.

Imperfect indexation

TIIS expose investors to at least three forms of basis risk (that is, the possibility that the financial instrument is an imperfect hedge against the risk the investor faces).

First, TIIS payoffs are pegged to the consumer price index, which is not a good proxy for the price level relevant to all investors (for example, a foreign investor).

Second, the method of calculating the CPI in the future can be altered to the detriment of a TIIS investor. Third, there is a two-month lag between the public announcement of the CPI and the corresponding adjustment in the face value of TIIS (note: the lag is eight months in the United Kingdom). Thus, a TIIS investor is unprotected against inflation risk during the last two months of the security’s life. All three forms of basis risk should cause TIIS yields to be higher than the hypothetical real interest rate, although reliable estimates of these yield premiums are not available.

Other risk and liquidity premiums. As noted above, the off-the-run illiquidity premium in TIIS is likely to be in the range of 5 to 20 basis points. The bid-ask spread in TIIS is likely to add up to another 5 basis points to a trader’s costs (Dupont and Sack, 1999). Evans (1998) identifies a statistically significant and time-varying risk premium unique to British index-linked yields (versus conventional bonds) over the period 1983-95 that averaged about 1.5 basis points. This risk premium is independent of any tax or basis-risk effects; it is essentially the price investors demand for giving up some desirable features of nominal government bonds such as high payoffs under deflation and smaller capital losses when real interest rates rise.

Note that the oft-discussed inflation-risk premium is a component of the nominal yield, not the TIIS yield. Empirical estimates of this premium in the United States and the United Kingdom range from zero to 150 basis points. Evidence from Britain (Evans, 1998) strongly rejects the hypothesis that this risk premium is zero, and the evidence also suggests that it is time-varying. Given the low and stable survey expectations of long-term U.S. inflation from today forward, it is plausible that the inflation-risk premium contained in current nominal Treasury yields is at the lower end of the estimated range.

Tax considerations. Normal increases in the face value of TIIS principal due to inflation indexation are taxable gains to investors, as described above. Hence, required yields should increase on TIIS whenever expected inflation rises and vice versa (Kopcke and Kimball, 1999). This creates a positive correlation between TIIS yields and expected inflation—contrary to the intuition of the Fisher equation, which postulates a zero correlation between the ex ante real rate and expected inflation. A positive correlation biases the spread between nominal and indexed securities—a measure of the inflation premium investors demand—toward zero, reducing its informativeness. This distortion is worse when inflation expectations are changing. It is probably very low now because survey measures of long-term inflation expectations are relatively stable. For example, the 10-year inflation forecast from the Survey of Professional Forecasters has remained in the 2.2 to 2.6 percent range for more than two years.

It will not be known until after the fact but we suspect that several of these factors are contributing to the current spread, but perhaps especially differences in the relative liquidity of TIPS versus bonds, given today's unusual circumstances. Comments on the site of the Cleveland Fed support this idea.

TIPS Expected Inflation Estimates

October 31, 2008

We have discontinued the liquidity-adjusted TIPS expected inflation estimates for the time being. The adjustment was designed for more normal liquidity premiums. We believe that the extreme rush to liquidity is affecting the accuracy of the estimates.

[Finster]

Re: Future inflation fears topple TIPS - Eric Janszen

Finster,

Regarding the recent spike in TIPS yields, the conclusion that the huge negative increase in the spread between TIPS and bonds yields is due to a rise in deflation expectations makes sense when the two are in equilibrium via arbitrage but clearly today they are not. Some as-yet unknown factor that is distorting TIPS prices...

A research paper by the St. Louis Fed...

EJ, the Fed paper supports what I've been saying:

Note the if's of course. TIPS. I do not like them, Sam I Am. Just for starters, they're marketed as "Inflation Protected" - but they are not. They're indexed to the CPI, which is not the same thing as inflation. EJ discusses this above...

TIIS payoffs are pegged to the consumer price index, which is not a good proxy for the price level relevant to all investors ... the method of calculating the CPI in the future can be altered to the detriment of a TIIS investor...

For another thing, like other investments, it is nominal returns that are taxed, not real returns, which means you can easily wind up with a negative after tax return, hardly befitting an ostensibly inflation-protected investment...

Tax considerations. Normal increases in the face value of TIIS principal due to inflation indexation are taxable gains to investors, as described above....

The CPI (along with most other government data) are lagging indicators … deflationary-looking CPI readings for a while thereafter will at least partially reflect deflation that has already happened, not necessarily actual future deflation.

Third, there is a two-month lag between the public announcement of the CPI and the corresponding adjustment in the face value of TIIS...