TIPS Trading Action Shows Inflation Will Remain Tame Until Economy Picks Up Steam, Giving The Fed Room To Continue QE3

Tuesday, December 11, 2012 08:17
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TIPS Trading Action Shows Inflation Will Remain Tame Until Economy Picks Up Steam, Giving The Fed Room To Continue QE3

Tags: Economic Outlook | Federal Reserve | Treasury bonds

Back in August when the jury was still out on whether the Fed would do another quantitative easing, some investors were buying 30-year Treasuries, the securities most vulnerable to rising consumer prices.

 
It turned out to be a smart move since QE3 did not ignite the inflation monster as many had feared. Long-term Treasuries gained 6.42%, handily beating the performance of 1.37% by Treasury Inflation Protected Securities (TIPS).

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Now, it appears inflation will stay at bay until the economy recovers in earnest. Expectations are high that the Fed will vote at its December 12 meeting to continue its bond-buying program.
 
The lack of growth in wages has kept inflationary pressures low and, in turn, allowing the Fed to pursue an unprecedented level of accommodation that has likely fueled the economic recovery more than we might have seen otherwise.
 
But inflation concerns are in line with history. Two months after the Fed’s first quantitative easing (QE1) announcement, TIPS had returned .6% against a loss in long-term Treasuries of 5.3%.
 
Two months after QE2 was announced, TIPS lost 3.6% and long-term Treasuries lost 4.9%.
 
If the US currency declines, consumer prices may indeed go up since a cheaper dollar makes commodity imports more expensive.
 
The S&P GSCI Total Return Index of commodities rose 20% before QE3 was announced but has declined 9.1% since.
 
This means that until inflation picks up, the Fed has more room to provide stimulus for job growth. The latest unemployment report showed a drop to 7.7% from 7.9% the previous month and 8.1% three months before.

 

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