Tuesday, October 26, 2010

Bond buyers think inflation will rise

Yesterday the U.S. Treasury sold a five-year $100 bond for $105.50.  Are people knowingly paying the feds to borrow money from them?  No, markets have not gone completely insane.  Today's NYT reports that these are TIPS (Treasury Inflation-Protected Securities) bonds, which guarantee that the principal will not be eroded by inflation.  This is done by indexing the $100 to the Consumer Price Index.  Compared to the yield on regular bonds, the market is in effect signaling that it expects inflation to rise over the next five years and is willing to pay a premium to hedge against that risk. 

NYT also reports fears that the Russian drought and extreme weather in the U.S. corn belt will shift food prices upward over the next few months.  With the Fed expected to buy more long-term bonds in the coming months, are we looking at a replay of the 1970s with high inflation AND high unemployment?

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