Even now, however, the breakeven inflation rate (the difference
between yields on conventional and inflation-linked bonds) on five-year Treasury
issues is just 2.4%, within the range it has occupied for the past four years;
compare that with the 7.7% inflation rate that American consumers expect over
the next 12 months.
“One possibility is that the
‘bond-market vigilantes’ have been asleep. ‘We sometimes wonder if Treasury-bond
investors enjoy losing money,’ muses Tim Bond, a strategist at Barclays Capital,
as he ponders the logic of owning ten-year Treasuries yielding close to 4% when
headline inflation is heading (on his view) for more than 5% by
August.
“Bill Gross of Pimco, a bond-market
investor, argues that inflation is understated in the official American figures
because of statistical adjustments made over the past 25 years. The result may
be that investors have been fooled into buying Treasury bonds on unrealistic
expectations of real (after-inflation) yields.
“Another possibility is that breakeven
rates are not an effective measure of investors’ inflation expectations. That is
the view of Jack Malvey, a strategist at Lehman Brothers. He argues that yields
on inflation-linked bonds have been distorted over the past decade by demand
from pension funds, which see the bonds as an ideal way to match their
liabilities.
“A third option is that bond investors
think today’s inflation rates are a blip. ‘Inflation may be an issue now but it
likely won’t be over the next ten years,’ says Pavan Wadhwa, head of European
rates strategy at JPMorgan Chase. Optimists argue the anti-inflation credibility
of central banks is stronger than in the 1970s. And they note that high oil
prices, although they push up inflation in the short term, ultimately tend to
act as a tax on growth.
“The credit crunch may also be having
lingering effects. Bond yields reached their low in mid-March when the Bear
Stearns crisis was in full swing. At that point, the ten-year Treasury bond
yielded just 3.31%, the lowest level in five years. Investors were fleeing the
riskier debt of bank and other corporate borrowers for the safety of government
paper.
“Yields have moved up by more than half
a percentage point since then, as investors have started to move money out of
government bonds and back into the equity market. But recessionary fears still
linger, especially when investors are bombarded with statistics such as the
continued fall in American house prices and the decline in consumer confidence.
