The part of the US Treasury market that protects investors from rising consumer prices is now facing uncertainty after the White House said the October consumer price index (CPI) may not be released.
This matters because Treasury Inflation-Protected Securities (TIPS) use CPI data to calculate how much interest investors are owed. Without those numbers, payments cannot be calculated normally.
TIPS work by paying lower base interest than regular government bonds, while the principal amount adjusts with the CPI.
The CPI data is used with a two-month delay, which is why the late release of September numbers has not yet triggered any backup rules. But if the October CPI is not published by the end of November, fallback procedures will start for the first time.
Fallback procedures create uncertainty
Jonathan Hill, head of US inflation strategy at Barclays Capital, said this situation is similar to past moments when the national debt limit created concern about delayed Treasury payments.
Jonathan said, “I’ve been saying this is the debt-limit equivalent for the TIPS market, something we all need to pay attention to and hopefully doesn’t come to pass.”
But if the October data is still missing by late November, the fallback will apply not only to TIPS, but also to inflation swaps, which are contracts where a floating rate is exchanged for a CPI-based payment.
Even if the CPI numbers are eventually released, their accuracy may be questioned. The White House said the government funding lapse has prevented price survey teams from gathering data, which means the CPI may not truly reflect conditions, and that uncertainty alone will definitely cause volatility.
Investor demand reacts to data quality concerns
Interest-rate strategists at Morgan Stanley, led by Aryaman Singh and Matthew Hornbach, said there are “concerns over deteriorating CPI data quality” due to weaker data collection during the shutdown.
The strategists think this may be reducing investor demand for the roughly $2 trillion TIPS market, and may also explain why some exchange-traded funds that hold TIPS have recently seen outflows, while regular Treasury bonds have performed better.
Aryaman and Matthew wrote, “As the data quality of CPI deteriorates, the demand for TIPS decreases as investors believe that they aren’t getting hedged against true inflation.” They added that weaker data could force TIPS to require a higher term premium than normal Treasuries.
TIPS have already underperformed regular Treasuries since mid-July. One contributing factor has been a drop in oil prices, which pushed gasoline to its lowest level since December. Since gasoline makes up around 3% of the CPI, lower fuel prices reduce demand for inflation protection.
At the same time, larger TIPS exchange-traded funds have not yet seen significant shrinkage. Investors who rely on these products for liquidity are not expected to exit suddenly.
Jonathan said the disruption does not represent a major threat to the market unless it becomes long-lasting.Gang Hu, managing partner at Winshore Capital Partners and a specialist in inflation products, agreed, saying that as long as the CPI remains free from political interference, the situation should remain manageable.
Gang said, “I don’t think it moves the needle here.” He added that if political interference were to occur, “we might be dealing with bigger problems before we deal with ‘Do people buy TIPS?’”
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