tips trading

good morning. Yesterday morning, a Washington Post article suggesting that President Donald Trump may impose selective rather than universal tariffs sent the dollar lower. He called the article “fake news” and the dollar recovered slightly. No one knows anything about Trump II’s tariff policies, and no one will know for some time. Everyone, please enjoy dollar trading. If you have time, please email us at robert.armstrong@ft.com and Aiden.reiter@ft.com.

’25 Tips

Treasury inflation-protected securities (U.S. Treasuries whose value adjusts periodically to compensate for inflation) have outperformed regular U.S. Treasuries and bond benchmarks over the past six years. This isn’t all that surprising. There’s been a lot of inflation, and chips are meant to hedge against that.

But tips don’t outperform every time inflation rises. Like other bonds, chips are sensitive to nominal interest rates, and if the rise in interest rates is greater than the rise in inflation (or more appropriately, break-even inflation, the market’s expectations of future inflation), chips will underperform. Form. What made the 2019-2021 period, when Tips performed so well, was special was that nominal interest rates were either falling faster than inflation (from early 2019 to mid-2020), or they weren’t rising as fast as inflation. (from mid-2020 to 2021).

This chart uses a short-term chip index and a government bond index. This is because it is the most actively traded part of the chip market.

And what caused it? In the early period, nominal interest rates (light green line) declined, first as the Federal Reserve went from raising rates to cutting rates, and second, as the pandemic hit, dashing growth expectations and forcing the Fed to cut rates. and remained at a low level. zero. All the bonds worked then. Inflation took hold in the second period, but nominal interest rates did not rise as fast as inflation, allowing Tips to significantly outperform other bonds.

Some observers argue that we are facing a new period in which nominal interest rates do not rise while inflation expectations rise. This is an ideal setup for the chip. The breakeven inflation rate currently stands at 2.4%, which hasn’t risen much since the Fed’s December meeting. This could be a sign of confidence in the central bank’s ability to control inflation. However, it may also reflect uncertainty about the impact of President Trump’s proposed immigration and tariff policies on inflation.

If the market comes to believe that President Trump’s policies are indeed inflationary, and the Fed is subsequently forced to hold interest rates steady, TIPS should outperform. Guneet Dhingra, head of U.S. rates strategy at BNP Paribas, said:

The Fed will have to do some work (on tariffs and immigration), but not in a way that will completely stop inflation. We expect the Fed to keep interest rates on hold. . . This is a perfect combination, and the chip protects you from inflation risk even without a reaction from the Fed (lower nominal yields). Both the tip rate and the break-even point are beneficial to investors.

Importantly, in contrast to government stimulus and fiscal expansion, tariffs and immigration policies can increase inflation without significantly increasing deficits, causing nominal yields to rise and tipping (and all other bonds) This means that there is a high possibility that profits will be lost. If Elon Musk and Vivek Ramaswamy’s Governor General initiative succeeds in cutting the budget, it could also lower the government’s borrowing costs, lowering real yields and boosting chip returns.

The obvious counter-argument is that President Trump’s policies, especially his proposed tax cuts, appear fiscally expansionary unless balanced with other sources of revenue (tariff revenue probably won’t be a sufficient offset). . Fiscal expansion would push up breakeven inflation, but it would also push yields higher, pushing down chip returns. Brij Khurana of Wellington Management says whether the hints really shine will depend on fiscal policy, not just the Fed. But either way, with inflation accelerating, “it’s good to own protected bonds, not just Treasuries,” Khurana said.

(Reiter and Armstrong)

Question for readers: Industrial production

The US goods economy has been in a bad state for more than two years. Industrial production has been flat since spring 2022. Logistics industry executives constantly talk about a “cargo recession.”

However, recently there has been a whiff of good news. In the widely followed ISM Manufacturing Survey, the new orders component, considered a leading indicator, has been above 50 (indicating expansion) for the second month in a row. Apparently, this depressing trend has been broken.

There are several possible interpretations of the data. New orders may be responding to higher fundamental demand. Or you may be a buyer looking to get ahead of potential tariffs and associated price increases. Or maybe it happened suddenly.

Which one do you think?

A book I read often

The U.S. job market may not be so strong after all.

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