Tarriffs, TIPS, Curve Slope, & the 3% Level: Growth vs. Value
Talk of the Trump Administration hitting China with Tariffs has taken center stage in the news cycle again and the Treasury Inflation Protected Securities (TIPS) market is again taking this seriously. While the expression “buy the dips” used to applied to stocks; we believe “buy the dips” now also applies to TIPS in the age of Trump.
TIPS are priced based on the Consumer Price Index and the next round of tariffs, if they occur, will have a meaningful impact on consumer products based on preliminary analysis. This makes TIPS break-evens an important barometer of the market’s estimate of the probability of tariffs actually happening – today TIPS investors are believers.
As the intraday data for TIPS break-evens below shows, TIPS traders were initially disappointed by Thursday’s CPI data and they sold TIPS relative to nominal Treasuries and TIPS break-evens fell. This was a “Buy the Dip/Buy the TIP opportunity.” Expectations for CPI were 2.8%, the print was 2.7%, and while traders may have been hoping for a higher than expectation number (and sold), we believe longer-term investors should trade against short-term traders and add to positions on this behavior. As seen in the chart below, TIPS beak-evens stabilized and expanded on Friday, and are rising again this week on the tariffs news.
10-YEAR TIPS BREAK-EVENS
Source: Bloomberg. Data accessed on 9/17/2018
Rising inflation expectations today and concerns about the inflationary impact of Tariffs is also expressing itself in the slope of the treasury yield curve. The table below shows that curve slope across almost every maturity has been steepening. While the amounts are small, it is worth observing how interconnected these trades are.
TREASURY SLOPE ACROSS DIFFERENT MATURITIES
Source: Bloomberg. Data accessed on 9/17/2018
Significantly, all of these investment themes intersected on a day when the 10-year Treasury again tested the important 3% level. Many market observers thought there would be a break through to the upside earlier this year when the 10-year Treasury briefly surged about that level, before being brought back within the trading range by stock market turbulence. If there is a break in the 10-year Treasury, we believe it could be the beginning of something more important.
10-YEAR TREASURY
Source: Bloomberg. Data accessed on 9/17/2018
The Russell Benchmarks appear to be paying attention at the open. The final two charts show the immediate market reaction by the Russell 2000 Growth (RUO) and Russell 2000 Value (RUJ) indices. In the first minutes of the trading day yesterday, Value was outperforming. This makes sense as higher inflation expectations tend to depress P/E’s. This is a bigger risk for growth stocks and a support for lower valuation companies.
RUSSELL 2000 GROWTH INDEX
Source: Bloomberg. Data accessed on 9/17/2018
Jonathan E. Lewis, Chief Investment Officer
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1. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
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