Retirees, senior citizens and “widow and orphan” investors got some good news from Wall Street on Tuesday. But don’t worry if you missed it, because everyone else did too.
The news was a double whammy. The first was that inflation expectations remain far lower than the ever-popular worst-case scenario. The second was that, in case these lower expectations turn out to be wrong, insurance against higher inflation is reasonably cheap.
This news came courtesy of one of the most important reports of the month, the Bank of America Securities’ global fund manager survey. Every month the bank’s strategists poll major money managers around America and overseas to find out what they’re thinking and how they are currently invested. This month, the bank asked over 250 pension fund managers and chief investment officers, who are collectively handling over $700 billion in assets.
“Everyone… expects inflation to fall,” wrote the bank’s strategy team, headed by Michael Hartnett. Those expecting inflation to fall greatly outnumbered those expecting anything else.
The consensus on lower inflation, the bank said, is the strongest since the global financial crisis of 2008 that followed the collapse of Lehman Brothers.
Money managers also expect a plunge in economic growth and a recession — either now or pretty soon. (Real-time economic data tracked by the Atlanta Federal Reserve says we are already in a recession — a finding that doesn’t quite fit with the most recent jobs and inflation numbers).
The survey helped explain one of the weirdest things that has been going on for months in the markets, while attracting precious little commentary. So many well-paid talking heads — not the broken watches who are right twice a day, but the expensive broken Rolexes, who are often wrong but never in doubt — have been saying over and over again that inflation is out of control, the Federal Reserve has lost control of expectations, and that we are hurtling back to the 1970s.
Meanwhile, the multi-trillion dollar bond market, which should be predicting this chaos, has instead been expecting something different. The bond market has been predicting that the huge surge in inflation will quickly fade and reverse, and that, over the next 5 years, it will average less than 3% a year. The current five-year inflation forecast is just 2.67%, down nearly a full percentage point from its peak in March. At no point has the forecast been close to 4%.
I don’t pretend to know what inflation is going to be. But unlike the broken Rolexes, I do try to listen to the market. If the bond market thinks inflation is going to average 2.7% over the next five years, and these people think that is wrong, they surely owe us at least some explanation of why they think the market has it wrong. There are billions, literally, to be made quite easily if you know for certain that the bond market is wrong. I don’t understand what these people think they know that the bond market doesn’t know.
The Bank of America survey showed that most big money managers agree with the bond market. But this week’s survey also showed that the market is at least rationally responding to the weight of money.
This is good news for cautious investors, including senior citizens, who are usually the most at risk from a sustained surge in inflation. Older investors tend to hold more bonds because they need the stability of income, but bonds are generally the most exposed to rising inflation. Meanwhile, Social Security cost of living increases, which are supposed to compensate seniors for rising prices, only occur once a year and in arrears. This year’s COLA, which took effect in January, is 5.9%, though prices in June were 9.1% higher than a year earlier.
So if the inflation rate cools down, that’s going to be good news for seniors.
But there is a second and more useful item of good news in the survey.
Thanks to this current consensus on falling inflation, you can buy inflation insurance right now reasonably cheap. And I can’t think of a compelling reason why you wouldn’t.
There are two kinds of Treasury bonds issued by the U.S. Government. The first ones, which are the main market and the best known, pay a fixed rate of interest. Right now, for instance, the 10 Year Treasury Note will pay 3.05% interest for the next 10 years. The second kind (through a complex and highly technical mechanism) adjusts the rate of interest to reflect the inflation rate. It is the relative prices of the two kinds of bonds that constitute the bond market’s implied inflation forecast.
I have always preferred the second type, known as Treasury Inflation-Protected Securities. They’ve been around only since the late 1990s and they are generally under-owned. But nominal returns of 3% won’t help if costs are rising 6%. Regular Treasuries are good for making a bet on where inflation could be headed. But most people do not want to make a bet — meaning TIPS bonds could be more beneficial.
Right now TIPS bonds look like a reasonably good value. Short-term, medium-term and long-term TIPS all currently promise to pay you more than inflation from today until 2052, no matter what inflation turns out to be.
Five-year TIPS will pay you inflation plus 0.5% a year. Thirty-year TIPS will pay inflation plus 0.9% a year. Those numbers have been rising this year — an especially odd phenomenon at a time when everyone has been shocked by surging inflation, and when even big money managers — according to the latest survey — admit that persistent inflation is the biggest “tail risk” they fear.
And the reason is pretty simple. TIPS are reasonably cheap and out-of-fashion because institutional investors all think inflation is going to be no big deal and that it will soon plunge again. Effectively “everyone,” as Bank of America puts it, thinks inflation is heading back down.
It’s not certain where inflation is headed. But I am suspicious of anyone who is so confident about the future. It makes no sense. And when the fund manager survey shows an emphatic consensus in one particular direction, it usually means watch out ahead.
Anyone owning regular Treasury bonds instead of TIPS at the moment is actually making a bet that inflation will average 2.7% a year or less over the next 5 years.
Do you want to take that bet?