Good morning. A Washington Post story suggesting that Donald Trump might impose selective rather than universal tariffs sent the dollar down yesterday morning. He said the story was “fake news”, and the dollar recovered somewhat. Nobody knows anything about Trump II’s tariff policy, and nobody will for a while. Have fun trading the dollar, everyone, and if you have a moment, email us: robert.armstrong@ft.com and aiden.reiter@ft.com.
Tips in ’25
Treasury inflation protected securities — Treasuries whose value is periodically adjusted to compensate for inflation — have outperformed plain vanilla Treasuries and fixed-income benchmarks over the past six years. This is not too surprising: there has been quite a bit of inflation, which is what Tips are meant to hedge against.
But Tips don’t outperform every time inflation increases. Like any bond, they are sensitive to nominal interest rates, and if the increase in rates is greater than the increase in inflation (or, more properly, break-even inflation, the market’s expectation of future inflation), Tips underperform. What was special about the years 2019-2021, when Tips performed so well, was that nominal rates were either falling faster than inflation (early 2019 to the middle of 2020) or not rising as fast as inflation (mid-2020 through 2021).
We’ve used short-term Tips and Treasury indices in this chart because that is the most actively traded part of the Tips market:
And what made that happen? In the earlier period, nominal interest rates (the light green line) dropped and stayed low as, first, the Federal Reserve went from raising rates to cutting them and, second, the pandemic hit, crushing growth expectations and forcing the Fed to cut to zero. All bonds did well then. In the second period, inflation took hold, but nominal rates did not rise as fast as inflation, allowing Tips to massively outperform other bonds.
Some observers argue we are in store for another period in which inflation expectations rise and nominal rates do not — the ideal set-up for Tips. Break-even inflation is now at 2.4 per cent, and has not risen much since the Fed’s December meeting. This could be confidence in the central bank’s ability to keep inflation down. But it could also reflect uncertainty about the inflationary impacts of Trump’s proposed immigration and tariff policies.
If the market grows to believe Trump’s policies are, indeed, inflationary, and if the Fed is then forced to hold rates steady, Tips should outperform. From Guneet Dhingra, head of US rates strategies at BNP Paribas:
The Fed will have to react to [tariffs and immigration policies] somewhat, but not in a way they can fully stop inflation. We expect the Fed to keep rates unchanged . . . That is the perfect combination, where Tips will protect you against inflation risk, without the response from the Fed [that lowers nominal yields]. Both rates and the break-even side of Tips will be beneficial to investors.
Importantly, tariff and immigration policies could increase inflation without substantially increasing the deficit, as opposed to government stimulus and fiscal expansion, which would likely increase nominal yields and hurt returns on Tips (and all other bonds). Elon Musk and Vivek Ramaswamy’s Doge initiative, if it is successful at trimming the budget, could also lower borrowing costs for the government, bringing down real yields and boosting Tips returns.
The obvious counterpoint is that Trump’s policies appear to be fiscally expansionary, particularly his proposed tax cuts, if they are not balanced with other sources of revenue (tariff revenues probably won’t be enough of an offset). Fiscal expansion would push break-even inflation upwards, but raise yields at the same time, dragging down Tips returns. According to Brij Khurana of Wellington Management, whether or not Tips really shine will be down to fiscal policy, more than just the Fed. But either way, with inflation picking up, “[it’s good to] own protected bonds, rather than just Treasuries”, Khurana said.
(Reiter and Armstrong)
A question for readers: industrial production
The goods economy in the US has been in bad shape for more than two years. Industrial production has been flat since spring of 2022. Executives in the logistics industry constantly talk about a “freight recession”.
But there has been a whiff of good news in the air lately. In the widely followed ISM manufacturing survey, the new order component — considered a leading indicator — has been above 50 (indicating expansion) for two months in a row. It looks like the dreary trend may have been broken:
There are several possible interpretations of the data. It could be that new orders are responding to higher fundamental demand. Or it could be buyers trying to get ahead of possible tariffs and the accompanying higher prices. Or it could be a blip.
Which do you think it is?
One good read
Maybe the US jobs market is not all that strong, after all.
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