David Kotok, portfolio manager with Cumberland Advisors in Vineland, N.J., is looking at increasing the firm's Treasury Inflation Protection Security (TIPS) allocation by 10%, or an additional $25 million, within the next few months. Kotok says he will place more emphasis on buying 30-year TIPSs, based on the view that the Treasury's decision to suspend issuance of 30-year bonds will cause long TIPS to trade with a scarcity premium within a year or so. Kotok adds that all TIPSs will rally after Wednesday's 10-year auction but that the price appreciation should be greater on the long end than on the 10-year range TIPS with a premium reaching 30 to 40 basis points.
Kotok believes TIPSs will rally more than conventional Treasuries because the market is currently pricing CPI for the next 10 years at a 1.5% rate, a level Kotok believes to be too low and one that he estimates should more likely be 3-3.5%. He reasons that the market is wrong because a 1.5% CPI level will make the Federal Reserve's preferred inflation measure, the Personal Consumption Expenditure Deflator, zero, a violation of long standing Fed policy. Cumberland has a $250 million bond portfolio with an asset allocation of 50%TIPS, 35% taxable munis, 5% short-term Treasuries, 5% mortgage-backed securities and 5% cash. Kotok would not disclose duration given the portfolio's heavy allocation in TIPS.