How to Hedge Against the Treasury Bust

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There is one market that hasn't yet dried up with all the others: the treasury market.  As the stock markets bounce between recent lows and highs on economic news and corporate earnings releases, the market for treasuries is sitting at near a standstill.  Even as trillions of US debt will need to be funded this year, investors still have the same appetite for the securities.

Traders Reverse on Their Treasury Buying

Though traders have been buying treasuries since the early fears of deflation in the fall of 2008, they're starting to think differently about what products they're willing to hold.  Treasuries of all shapes, maturities and yields are being purchased; however, the new trend is in TIPS.  TIPS are inflation protected treasuries, meaning the United States Government guarantees a return that is higher than inflation by coupling CPI data into the yield.

What Investors Want

Investors want one thing: safety.  Protecting your assets comes first to investors before producing a profit, especially in today's economic environment.  Analysts watched as investors piled billions first into treasuries, then into gold, and now into the new wave of treasuries and TIPS investments.  Investors were concerned about deflation; however, those fears have quickly turned to inflation as trillions of government rescue dollars pour into the world's markets.

For How Much Longer Will TIPS Hold?

The treasury bubble burst has to yet formulate, and investors are starting to wonder at what point money will pour out of treasuries and into higher yielding equities.  The divide between current equity returns in 2009 and that of fixed income is monstrous; treasury holders have certainly missed out on the bull market run that began in early March and has thus far continued through earnings season.  Should inflation come into the scene and push up prices, holders of ordinary treasuries will be net sellers, but TIPS holders could swoop in to buy more at depressed prices.

CPI Data is the Key

Semi-annual CPI data is the most important factor to keeping TIPS afloat.  Since TIPS are hedged against changes in CPI rather than the change in money supply, it should only be natural that inflation be somewhat delayed in making its way to the markets and into CPI data.  Lower energy prices have kept CPI and prices as a whole to rational levels; however, many expect that oil prices will head higher during the summer of 2009, especially if the economy continues showing signs of improvement.

CPI – A Benefit and a Curse

CPI data has its share of criticism.  Though the index was created largely to judge changes in inflation and deflation, for many people and businesses, the numbers are skewed.  Some people spend far more money on food than they do personal healthcare products, thus the true calculation of inflation can only be seen at the most individual level.  Some businesses may see falling prices while other businesses, such as transporters and delivery companies, may see a huge jump in their operating budgets on higher fuel costs.  Buying TIPS only protects you from widespread inflation, but does little to protect from line by line or cost by cost inflation.

Playing TIPS on the Market

Treasury Inflation Protected Securities are immensely popular with exchange-traded fund investors.  The largest fund for the products, iShares Barclays TIPS Bond (TIP), absorbed billions of dollars in new investments in the first quarter of 2009 alone.  The fund contains $11.5 billion invested dollars and yields a whopping 5% dividend yield on profit-taking as CPI is adjusted.  That's certainly better than most treasury funds, which bask in 2-3% returns per year for long dated investments.

The Break to Basics

The last crash increased investors' interest in bonds, the real estate crash got people out of homes, and the newest financial crash is pushing investors to the most basic of safe investments.  There should be some concern from anyone who is invested in treasuries that that bubble may soon burst; however, TIPS owners are guaranteed at least some additional protection that other investors don't have.  Should inflation rise and bond prices drop, TIPS will be moderately hedged to the downside.  If you're long on treasuries, consider buying some TIPS as well; when inflation hits, they'll command a premium.

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