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TIPS’ Yields Show Fed Has Lost Control of Inflation

Posted by ecoshift on March 10, 2008

Bloomberg.com: Worldwide
TIPS’ Yields Show Fed Has Lost Control of Inflation (Update1)
By Sandra Hernandez and Deborah Finestone

March 10 (Bloomberg) — Bond investors have never been so sure that the Federal Reserve will lose control of inflation. They’re so convinced that they’re giving up yields just to buy debt securities that protect against rising consumer prices.

The yield on the five-year Treasury Inflation-Protected Security due in 2012 has been negative since Feb. 29, ending last week at minus 0.16 percent. The notes, which were first sold in 1997, have never before traded below zero. Even so, firms from Deutsche Asset Management to Vanguard Group Inc., the second-biggest U.S. mutual fund company, say TIPS are a bargain.

For the first time in a generation, money managers must come to grips with a central bank that’s more intent on spurring the economy than restraining price increases. With oil above $100 a barrel, gold approaching $1,000 an ounce and the dollar at a record low against the euro, TIPS show investors aren’t convinced Fed Chairman Ben S. Bernanke will be able to tame inflation once policy makers stop cutting interest rates.

“The way TIPS are trading now, investors believe headline inflation will stay lofty and are willing to give up the real yield for that,” said Brian Brennan, a money manager who helps oversee $11 billion in fixed-income assets at T. Rowe Price Group Inc. based in Baltimore. Prices for the securities indicate “a real concern of a recession and high headline inflation,” he said.

Because TIPS pay a principal amount that rises in tandem with the consumer price index, buyers accept lower yields in a bet the inflation adjustment will make up the difference.

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