LACKLUSTRE DEMAND FOR RECORD TREASURY INFLATION DEBT SALE / THE FINANCIAL TIMES ( RECOMMENDED READING )

Lacklustre demand for record Treasury inflation debt sale

By Michael Mackenzie

Last updated: January 20 2011 22:15

A record sale of inflation-protected US Treasury bonds on Thursday met lacklustre demand as investors were overwhelmed by the scale of the issue.


The Treasury sold $13bn of 10-year inflation-protected securities, or Tips, at a yield of 1.17 per cent, up sharply from an indicated level of 1.11 per cent just before the sale.


Long-term investors bought 38 per cent of the sale, below the six-month average share of 46.4 per cent.


“This auction is at least 30 per cent larger than any other 10-year Tips auction in history so the relatively weak stats may not be terribly surprising given the offering size,” said William O’Donnell, strategist at RBS Securities.


The difference between yields for two- and 30-year Treasury securities touched a record 400 basis points after the Tips sale.


With 30-year bonds largely influenced by long-term inflation expectations, the record premium over shorter-dated debt is further evidence that investors are concerned about higher prices in the future. As the global economy recovers and the Federal Reserve maintains its ultra-loose monetary policy by buying an extra $600bn of Treasury securities, financial markets have been pricing in the likelihood of a jump in inflation.


“There has to be some inflation premium in that relationship,” Mr O’Donnell said.


The 10-year break-even rate, the difference in yields between Tips and non-inflation protected bonds, now sits at about 2.35 per cent, and has climbed from 1.5 per cent since last August.


Over the next two months, the Tips issue will be reopened with expected additional sales of $11bn, creating the largest outstanding Tips security.


“Not a good auction at all,” said Richard Gilhooly, strategist at TD Securities after the sale. “This appears to be a sound rejection of the need for inflation protection.


Before the sale, traders reported good buying of 10-year Tips by foreign and domestic investors in recent weeks. This had been matched by evidence of rising concern over future inflation.


Last week, official data showed that US consumer prices rose 0.5 per cent in December, with higher oil prices helping to push the annual inflation rate to a seven-month high of 1.5 per cent.


The core rate of inflation, which strips out food and energy prices and which is watched by policymakers, remained steady at an annual rate of 0.8 per cent.


Policymakers argue that paying interest on bank reserves held at the Fed is likely to stem the flood of money into the broader economy.


However, analysts at Laffer Associates warned that robust money growth by the US Federal Reserve was likely to spark double-digit inflation before 2015.


Laffer warned: “Inflation expectations could become unanchored well before the banking system heals, igniting the inflation fire.”


“Long before the Fed gets around to draining reserves from the system, the banking system will have pumped far too much money into the economy. Brace yourself for the inflation wave,” they said.


Copyright The Financial Times Limited 2011.