The curious case of the TIPS auction

Oct 27, 2010

Baltimore, Maryland

What a whacky, whacky world...

"Debt sales highlight abnormal conditions," says the headline in yesterday's Financial Times.

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Abnormal? Freaky. Bizarre. Strange.

The latest auction of a TIPS - US Treasury debt with inflation protection - produced a curiosity. Investors were willing to pay $105 for every $100 worth of inflation-protected notes.

Go figure.

What does it mean? What are investors worried about? On the surface of it, they are setting themselves up for a built-in loss. TIPS always offer less interest than regular bonds. You give up some yield to pay for the inflation protection. But TIPS buyers are now buying them with negative yields. Which is to say, they pay for the privilege of owning the bonds. Inflation has to beat expectations...and then some...before they are even at breakeven.

All very weird. If they are so afraid of inflation, why not buy gold? No negative yield. You pay $ get $100 worth of gold.

And you won't have to worry about the people who are making the calculations. In the case of TIPS, the people who sell the notes are the same people who determine how much they're worth - because they're the people who figure out the CPI. Besides, we haven't studied the matter, but when we last looked into it, we found that there was a delay in making the adjustments.

So, in a period of really hyper inflation the adjustment process would be over-run by events. When Hungary had its hyperinflation of 1947, for example, the pengo lost half its value every 13 hours. No adjustment in the world can keep up with that rate of loss... a TIPS holder would be wiped out. A gold buyer, on the other hand, would be, well, golden....

The other strange thing about protecting oneself from inflation via TIPS is that there isn't any inflation to speak of. According to the people who keep the statistics, the rate of consumer price inflation is barely 1%. And according to the people who buy regular non-adjusted Treasury debt, there is no inflation on the horizon either.

All of which makes the TIPS auction curioser and curioser...

Stock market investors didn't seem to know what to make of it either. The Dow ended yesterday essentially unchanged.

Gold didn't know what to think. It didn't move yesterday.

And that's not's this for weird?

From Bloomberg:

"Dollar Gains Against Euro on Speculation Fed Easing Will Spark Inflation"

Huh? Investors worried about inflation in the dollar. They buy dollars? Yep.

"The dollar strengthened against the euro for the first time in three days on speculation that an increase in debt purchases by the Federal Reserve will cause inflation to accelerate.

"Sterling rallied against all of its major counterparts as a report showed that U.K.'s economy grew in the third quarter at double the pace forecast by economists and Standard & Poor's raised the nation's credit outlook. The yen dropped versus the dollar on the prospects of Japan renewing intervention to weaken the currency and protect exporters.

"Inflation expectations have been lifted because people think the Federal Reserve will be successful," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co. in New York.

The U.S. currency appreciated 0.8 percent to $1.3859 per euro at 5 p.m. in New York, from $1.3965 yesterday. The dollar gained 0.8 percent to 81.43 yen, from 80.81 yesterday, when it reached 80.41 yen, the lowest level since April 1995. The euro was little changed at 112.86 yen, compared with 112.85.

"The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against the currencies of six major U.S. trading partners including the euro, yen and pound, increased 0.7 percent to 77.6533. The gauge has fallen 1.4 percent in October on speculation that a boost in debt purchases, also known as quantitative easing, will erode the value of the greenback. The Fed is next due to decide on policy at its Nov. 2-3 meeting. "

The markets are seriously confused. Inflation? Deflation?

Well, what are we going to do?

We'll hold our gold. We'll sit. We'll laugh. And we'll wait for this whole shebang to go ka-plouey.

How's that?

More news...

And more thoughts...

*** A zombie alert. Bloomberg has the report:

"Chris Whalen is famous lately for predicting a return of the subprime crisis in 2011. His thoughts on the greater mortgage system are also interesting, as discussed in an interview with King World News.

"Whalen says GSEs [Fannie Mae and Freddie Mac] don't help homeowners. Rather they promote a system that locks marginal borrowers into costly interest payments, helping their own bottom line."

The zombies at Fannie and Freddie prey on house buyers.

We interrupt the normally crisp flow of ideas in these daily reckonings with a parenthetical remark. Looking through the newspapers and magazines this weekend we were offered thousands of 'homes' for sale. We thought a home was something you lived in. But the ads offer "new homes" - empty houses that no one has ever lived in. It doesn't make any sense to us. But we conclude that the word "house" has been withdrawn from the dictionary.

Yes, dear reader, the homing crisis in America only seems to get worse and worse. We remind readers too that this was a crisis created largely by the government - which subsidized mortgage rates (sponsoring Fannie and Freddie), provided a tax break for mortgage interest, and told banks that they had to lend to poor credit risks in bad neighborhoods.

And now, true to form...the government is making it worse. How? By bailing out failed lenders- Fannie and Freddie. The last estimate we saw put the cost of keeping these incompetents alive at more than a quarter of a trillion dollars. That is bad money after bad money, in our opinion. The Feds are also threatening to slow down the foreclosure process...which would further delay the correction in the homing market.

Now....Chris Whalen continues:

"If you're a wealthy American you can [refinance], but if you've got a seven-something FICO score and you're in a so-so neighborhood so the collateral doesn't have a big score in the equation, you're screwed," Whalen says. "These are the people Fannie and Freddie doesn't want to see prepay, so they can keep the income on their portfolio. It's horrible! People don't realize how predatory these government agencies are.

"Everything Orwell ever wrote was true and it's proven by the way people like Barney Frank and Chris Dodd have personally benefitted from this housing mess, while they're actually hurting the poor people most."

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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