For almost a year, Wan-Chong Kung avoided U.S. government debt insured against inflation as consumer prices stagnated.
Now the bond fund manager at Nuveen Asset Management, whose inflation-indexed fund has beaten 95% of its peers the last three years, is loading up on Treasury inflation-protected securities.
Her change of mind happened as Federal Reserve Vice Chairman Janet Yellen, who has voted for every stimulus measure since 2008, became the favorite to succeed Ben S. Bernanke as Fed chief and the central bank maintained its $85 billion a month in bond buying. Policymakers also said their target interest rate for overnight loans between banks may rise at a slower pace than suggested by historical measures.
That last big “dovish surprise” shows that the Fed is “continuing to err on the side of promoting sustained job growth, potentially at the risk of higher inflation,” said Ms. Kung, who helps manage $125 billion at Nuveen.
She has plenty of company. TIPS gained 3.5% from Sept. 5 to Sept. 26, the best three-week rally since August 2011, after losing 8.7% in the first eight months of 2013, the most ever in that period, according to Bank of America Merrill Lynch's U.S. Inflation-Linked Treasury Index.
Now fund companies from Nuveen to SEI Investments Co. predict that the Fed's continued stimulus will lift market expectations for faster increases in the consumer price index, leading to more gains for TIPS. Inflation-protected debt pays a lower coupon than nonindexed Treasuries. In exchange, investors receive an adjustment on the principal equal to the rise in the CPI.
Société Générale SA is recommending the debt even though economists at France's second-biggest lender are forecasting that inflation will remain subdued. The bank's fixed-income strategists suggested buying TIPS after the Federal Open Market Committee on Sept. 18 maintained the pace of bond buying and signaled that benchmark rates will remain low into 2016.
“The Fed was willing to lose a little bit of its credibility to be dovish,” said Jorge Garayo, a fixed-income strategist at Société Générale in London. It isn't clear if the Fed's reaction “to inflation will be different or not, but market participants believe it will,” he said.
Treasuries that aren't indexed for inflation, which erodes the value of bonds by reducing the purchasing power of a security's fixed payments, have gained 1.9% since Sept. 5, Bank of America indexes show, indicating little concern that inflation will get out of control.
Even in the wake of the Fed's purchase of more than $3.1 trillion in government and mortgage bonds, and its decision to hold its benchmark lending rate at about zero since December 2008, signs of rising prices remain scarce.
The Fed's preferred measure of inflation, the personal-consumption-expenditures deflator, rose 1.2% in August, down from a revised 1.3% increase the month before, the Bureau of Economic Analysis said Sept. 27. It has remained below policymakers' 2% target since April 2012.
NO "INFLATIONARY PRESSURE'
The gauge fell at an annual rate of 0.1% in the second quarter, the Bureau of Economic Analysis said.
“As far as I can see, you don't have any inflationary pressure,” said Dan Heckman, a fixed-income strategist at the U.S. Bank Wealth Management unit of U.S. Bancorp, which manages $110 billion.
Yields on 10-year TIPS fell 5 basis points in the one-week period ended Sept. 28, or 0.05 percentage points, to 0.45%, according to Bloomberg Bond Trader prices. Nonindexed Treasury yields of similar maturity declined 11 basis points to 2.63%.