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TIPS yielding 3%
Old 10-12-2008, 06:22 PM   #1
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TIPS yielding 3%

Has anyone noticed that 10-year TIPS are yielding nearly 3% real? According to Bloomberg, 10-year TIPS are yielding 2.96%, while 10-year Treasuries are yielding 3.87%, a break-even inflation rate of only 0.9%. Frankly, I don't understand why the implied inflation rate is so low.

The only thing I can think of is that a prolonged severe downturn will result in much lower inflation, with the high real rate implying a very high demand for credit by the US government. Usually, the real rate would fall during an economic downturn reflecting lower demand for money from the private sector. The surprising thing to me is that the market seems to be saying the government can borrow all this money without causing inflation down the road.

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Old 10-12-2008, 06:34 PM   #2
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That last sentence is what puzzles me. I understand the deflationary pressures created by a crash in financial markets and in a serious contraction of the economy. But I have trouble seeing those pressures overwhelm the inflationary pressures caused by all the borrowing and money-printing that will be needed to get out of it.

"Hey, for every ten dollars, that's another hour that I have to be in the work place. That's an hour of my life. And my life is a very finite thing. I have only 'x' number of hours left before I'm dead. So how do I want to use these hours of my life? Do I want to use them just spending it on more crap and more stuff, or do I want to start getting a handle on it and using my life more intelligently?" -- Joe Dominguez (1938 - 1997)
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Old 10-12-2008, 07:21 PM   #3
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The muni bond yield curve is rising across the board - what you'd expect if expectations are for increasing inflation.

The quoted NAV for my Vanguard TIPs fund has plunged the last couple of weeks. I won't speculate on causes - I've forgotten the details on how TIPs work.
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Old 10-12-2008, 07:39 PM   #4
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The world isn't worrying about inflation right now. The massive deleveraging going on is highly deflationary.

Keep in mind that the government creates money through the banking system's ability to turn $1 of deposits into multiple $'s of loans. If banks aren't lending (which they aren't) the Federal government has a very difficult time injecting liquidity into the economy. This is a classic "liquidity trap" which is deflationary.
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Old 10-12-2008, 08:04 PM   #5
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Originally Posted by . . . Yrs to Go View Post
The world isn't worrying about inflation right now. The massive deleveraging going on is highly deflationary.
So an alternative hypothesis for rising muni rates would be fears of increasing defaults if things get really bad? This explanation works for me, too.

I'm actually less worried about rising defaults than rising inflation, because I own muni bond funds rather than individual bonds. I hope my confidence isn't misplaced.
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