Pimco favours inflation bonds countering Fed caution on prices

[SINGAPORE] Pacific Investment Management Co is recommending Treasury Inflation Protected Securities even as tumbling oil costs prompt Federal Reserve officials to voice concern that consumer prices are stagnating.

An inflation rate that's stuck near zero combined with crude close to a 12-year low are driving speculation the Fed will delay its next interest-rate increase. The odds the Fed will follow its December boost with at least one more in 2016 have fallen to 72 per cent from 93 per cent on Jan 1, futures contracts show.

"One of the surprises in 2016 will be stability in inflation and in oil prices," said Mihir Worah, one of the three managers of the US$89.9 billion Pimco Total Return Fund, which is managed from the company's office in Newport Beach, California. "As inflation stabilizes and as inflation expectations stabilize, we think the Fed could hike more than what the market is pricing," he said in an interview Wednesday.

Pimco is reversing bearish bets on crude oil and other commodities to adopt neutral or bullish positions and using TIPS to guard against rising costs, he said. "The market is pricing 1 per cent inflation for 2016," Worah said. "We think inflation is likely to be closer to 2 per cent."

The call coincides with turmoil emanating from China that's prompting investors to cut inflation expectations across the major economies, with TIPS losing 2.9 per cent during the past year, while conventional Treasuries were little changed, based on Bank of America Corp data. The difference between yields on US 30-year Treasuries and similar-maturity inflation-linked bonds, a gauge of trader expectations for consumer prices over the life of the securities, dropped to 1.59 per centage points Thursday, the lowest since 2009.

Worah predicted in July 2014 core consumer prices excluding food and energy costs would climb to 2.3 per cent by the middle of 2015. The gauge was 1.8 per cent in June, and it rose to 2 per cent as of the most recent data available for November.

Fed Bank of St Louis President James Bullard, one of the most vocal policy makers in recent months arguing to raise interest rates, sounded a more cautious note Thursday by saying the latest tumble in oil prices may delay the return of inflation to the central bank's 2 per cent target.

'Becoming worrisome' "With renewed declines in crude oil prices in recent weeks, the associated decline in market-based inflation expectations measures is becoming worrisome," Bullard said in a speech Thursday.

Fed Presidents Charles Evans and Eric Rosengren have also voiced concern this week that inflation is too low. Bullard and Rosengren both vote on monetary policy this year.

Treasuries gained, with the benchmark 10-year note yieldfalling four basis points, or 0.04 percentage point, to 2.05 per cent as of 6:54 am in New York, according to Bloomberg Bond Trader data.

Low inflation is a global problem, said Stephen King, a senior economic adviser at HSBC Holdings Plc.

"We have lots and lots of deflationary pressures," he said in an interview in Singapore. "We've got central banks that have been desperately trying to push inflation higher. But inflation almost everywhere is too low. There's very little insurance against the possibility of another recession."

BLOOMBERG