naked capitalism

The movement in Treasury Inflation Protected Securities is a sign of investor desperation to find any shelter from inflation. And TIPS are only a partial inflation hedge. Their yield adjustment keys off the consumer price index, which due to modification to the index (to contain CPI adjusted Federal benefits) lags broader measures of inflation.

From Bloomberg:

Yields on five-year Treasury Inflation-Protected Securities fell below zero for a third day on investor speculation that inflation will quicken as the U.S. economy slows.

Yields on the securities, known as TIPS, dropped to minus 0.036 percent on Feb. 29, according to Barclays Capital Inc., the biggest dealer of the securities. It was the first foray below zero since five-year TIPS were first sold in 1997, according to the firm, one of the 20 primary dealers that trade directly with the Federal Reserve.

“Demand has increased as investors are becoming more aware of inflation pressures,” said Michael Pond, an interest-rate strategist at Barclays in New York. As prices of commodities like gold and oil rise, “investors are pricing in relatively high inflation even though growth is slow and the Fed is likely to continue to move the fed funds rate lower.”

The 2 percent inflation-indexed security due in April 2012 fell 2 basis points to minus 0.04 percent today, according to Barclays. Five-year TIPS yield about 2.35 percentage points less than similar-maturity Treasuries, reflecting the rate of inflation investors expect over the life of the securities.

TIPS pay a lower rate of interest than regular Treasuries because their principal rises in tandem with a version of the consumer price index that includes food and energy prices. Rising demand for TIPS indicates investors expect the inflation adjustment to make up the difference.

U.S. consumer prices climbed 4.3 percent in the year through January, close to the highest since June, the Labor Department said last month. Crude oil, one of the biggest drivers of TIPS yields, rose to $103.33 a barrel today and is up 69 percent this year.

The Treasury stopped selling five-year TIPS between 1998 and 2003, and resumed auctions in October 2004. In addition to the current five-year security, seven other inflation-indexed notes with up to four years to maturity currently yield less than zero.