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Inflation Fears Could Impact Treasury Values.

Three months ago, many bond investors were bracing for deflation.  Three months later, many are now concerned about inflation.  These worries have not yet manifested themselves in Treasury bond prices but are evident by the record demand for TIPs or Treasury Inflation Protected bonds.

Bloomberg reports TIPs volume reached a record 2.75% of all Treasury trades during the past 30 days.  The most recent TIPs offering, investors purchased 72% of the auction, the greatest proportion since at least 2003.

As written, inflation expectations have changed radically since the beginning of the year.  It is now thought inflation will average 1.7% a year in the next five years which is 0.50% higher than expectations three months ago.  This is the biggest jump in over four years Bloomberg reports.

The primary reasons…an unprecedented 21 countries with negative sovereign debt yields, fears the Fed may fall behind the proverbial curve, oil and the rise in housing prices.

At the beginning of the year, oil and most other commodities were in a free fall.  Today oil is trading at 2015 highs, up about 31% from its mid-March multi year lows.  Owners’ Equivalent Rent (OER) or what someone can rent their house if it were indeed rental, rose to the highest level since 2008.  Depending upon the benchmark used, OER is between 31% and 35% of the indices.

A consistent theme of these remarks is the velocity of change.  Yesterday I wrote in tightening phases past, the vast majority of the increase in treasury yields occurred in two months.

While I am not suggesting yields will spike in the immediate future, I am only commenting about a possible change in psychology that could potentially impact Treasury values.

All must remember inflation is a two part phenomena…too much money chasing too few goods fearing higher prices tomorrow.   In other words, inflation has a monetary and a psychological component.

Today is the commencement of a two day FOMC meeting.  No change is expected policy but it is the post meeting statement that all will focus upon.

Commenting about yesterday’s market, activity was relatively quiet. Biotechnology and technology share were “soft.”  Commodity producers—a proxy for inflation–were strong.

Regarding profits, first quarter earnings are now forecasted to drop by 2.9%.  Two weeks ago analysts thought a 5.6% decline was plausible.

Last night the foreign markets were mixed.  London was down 1.11%, Paris down 1.69% and Frankfurt down 1.36%.  Japan was up 0.38% and Hang Sang up 0.03%.

The Dow should open moderately lower ahead of the two day Fed meeting.  Moreover there are 40 S & P 500 companies posting results today.  How will the earnings be interpreted?  The 10-year is unchanged at 1.93%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.