Actions Speak Louder Than Words

By: Michael Ashton | Wed, Sep 7, 2011
Print Email

I start today with a couple of simple news items that I think speak volumes. However, in my normal fashion I will then write further volumes.

As additional commentary in the "one picture is worth a thousand words" category, see below the Indian inflation trade (in red) and the German inflation rate (in white). One of these wants to issue inflation-linked bonds; one has abruptly decided not to issue any more right now because they don't need the money and besides, no one wants them.

India and Germany Inflation
One of these countries evidently believes their inflation is going to go down.
One is less sure.

Hmm. I would say 'draw your own conclusions,' but let me take you one more step.

Emerging economies issue ILBs for two main reasons. One is that many emerging markets cannot access the debt markets without indexing principal, since they have a history of devaluing the currency they pay back the bonds with. The other reason is that they want to indicate a seriousness about getting inflation under control, since clearly their interest payments will be less in nominal terms if they can restrain inflation.

Developed economies can stop issuing ILBs for a number of reasons, including an outstanding budget situation with projected surpluses and lack of investor interest. But if I was in the national Treasury, watching inflation crawl higher, and realized that I wasn't in control of the money-printing process, then unless I had to raise as much money as possible (the situation the U.S. is in, by the way) I might consider whether inflation-linked bonds were the best vehicle.


The bond market today roughly broke even, which is a fairly weak performance considering that the stock market started the day plunging. Equities were trying to catch up with the 2-day decline in Europe, and doing a darn good job of it until the S&P hit the upward-sloping trendline off recent lows (and parallel to highs of the recent consolidation, forming what looks unfortunately like a 'flag' on daily charts) and began to rally back. The net result, a loss of only -0.7% on fairly light volume - by recent standards - of around 1bln shares, was positively heart-warming and the market continued to rally after the close.

This may be premature. The German Constitutional Court is due to rule on Wednesday (that's after I post this at and release it on Twitter as @inflation_guy but possibly before it appears in syndicated channels) on whether the bailouts of Ireland, Portugal, and Greece that were financed by the European Financial Stability Facility are illegal. The consensus is that the court will not declare it to be so, but the consensus appears to believe that simply because it would cause unfathomable chaos almost immediately. A bailout mechanism without Germany is not a bailout mechanism, it's a bunch of drowning people fighting over a single life preserver. But even if the consensus is correct, that doesn't mean the court will not greatly limit the prospective participation of Germany in the future, or at least limit the ability of the Chancellor to make bailout decisions essentially unilaterally.

That event is the key to tomorrow's trade, and it will be done before we wake up.

While bonds ended the day today near-unchanged, and stocks ended much closer to unchanged, TIPS got painfully smacked. The 10-year TIPS yield rose 8bps, and with unchanged nominal yields that produced an 8bp decline in 10-year breakevens. This means 10-year inflation swaps, illustrated in the chart below, are at the lowest level they've seen since the last growth scare, which not-coincidentally preceded Bernanke's Jackson Hole speech and the proposal of QE2.

10-Year Inflation Swaps
10-year inflation swaps from Bloomberg.
The yield here is in basis points, so 231 is 2.31%.

This strikes me as borderline crazy, but only borderline. If the growth data continues to do what it has done, then there will be better opportunities (finally) to buy TIPS and to go long inflation at dumb levels again. The 10-year inflation swap had much more business being around 2% before QE2 was launched than 10-year inflation swaps have being around 2.30% with a US QE3 being debated, QE preparing to launch again in the UK, the Swiss National Bank pledging to sell unlimited Swissy (which is an ease unless sterilized, which it doesn't appear to be), and the ECB buying bonds (and sterilizing imperfectly at best). However, investors insist on believing that inflation is related to growth, and inflation quotations could go significantly further south if there is a debacle in Europe.

Let's hope there's not a debacle, but that we get a chance to buy TIPS and inflation swaps cheaply again!



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

Copyright © 2010-2017 Michael Ashton

All Images, XHTML Renderings, and Source Code Copyright ©