The gap between yields on TIPS and nominal Treasuries is widening on inflation fears, with the January '07 TIPS issue's breakeven, as it is referred to, at its highest level since March of 1997. The breakeven hit 296 basis points last week, approaching the widest-ever level of 330bps set eight years ago.
Strong economic data and rising inflation figures caused a sell off in both the TIPS and nominal Treasuries markets. Yet TIPS lagged in the sell-off because rising oil prices, positive carry (the difference between the TIPS yield and the funding cost rate) and month-end index buying have each contributed to make TIPS attractive than their more traditional counterparts, according to Charles Lee, interest-rate strategist at UBS. Oil prices rose about 10% to $51.75 from $47.50 during February. While these factors have increased breakevens across the yield curve, the two-year TIPS have risen the most because they are most sensitive to changes in the consumer price index, he said.
To be sure, breakevens tend to increase from March to May because of the lag effect of CPI on TIPS yields. Once breakevens break the psychologically important 300bps barrier, TIPS buying will accelerate because investors will be confident CPI will stay high, according to one strategist. He predicted breakevens could easily widen by 5-10bps within the next three months.
