Inflation expectations are on the rise

In early 2016, renewed fears about China’s slowing growth and historically low oil prices further pressured the market’s already tepid inflation expectations. Inflation expectations, as proxied by 10-year breakeven inflation (BEI), are measured by the yield differential between like-maturity nominal and inflation-linked Treasuries. The chart shows BEI from 2010 through 31 March.

Since falling to a low of 1.20% in February, BEI has rallied on the back of rebounding oil prices, higher core U.S. prices and a dovish tone from the Fed at its March meeting. Even after this increase, BEI is still well below the 10-year average and the Federal Reserve’s inflation target.

PIMCO

The time to buy inflation protection is before inflation starts to climb. In PIMCO’s view, the market is still underestimating inflation, which creates a compelling opportunity for investors to access what we believe to be underpriced inflation protection via U.S. Treasury Inflation-Protected Securities (TIPS), especially relative to nominal Treasuries.

Some investors considering TIPS may be concerned about real yields, which are now close to 0% for 10-year maturities. However, we note that low real yields are embodied in every asset class and are not specific to TIPS. We see these real yields as attractive compared with the negative real yields in most of the developed world.

For more analysis of trends shaping the economic outlook and their investment implications, please read the latest Putting Markets in Perspective.

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