Tuesday, December 16, 2008

CPI plunges -- good news for TIPS

The CPI fell 1.7% in November, which was more than the expected fall of 1.4%. The CPI has now fallen by 2.8% from its high last July. The bulk of the decline was due to falling energy prices; the CPI ex-energy rose by 0.45% over this same period, and core (ex-food and energy) prices are up 2% in the past year. As I noted before, the TIPS market has been extremely worried about deflation, yet TIPS prices today rose on the news that deflation was worse than expected. What gives? Simply put, the deflation that has worried investors is now old news, water under the bridge. More importantly, perhaps, we aren't seeing signs that deflation is spreading to any meaningful extent; it's largely confined to energy and commodities, and those prices are down hugely from recent highs. So TIPS are up because investors are now less worried about the prospects of more deflation.

As I noted here, the unadjusted CPI is always weak around this time of the year, and it is always strong in the early months of every year. So TIPS investors are now beginning to position themselves for the positive increases in the unadjusted CPI which will feed into TIPS portfolios beginning next March.

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