Martin Feldstein Finds Investors Who Do Not Buy or Sell assets
CAMBRIDGE – Inflation is now low in every industrial country, and the combination of high unemployment and slow GDP growth removes the usual sources of upward pressure on prices. Nevertheless, financial investors are increasingly worried that inflation will eventually begin to rise, owing to the large expansion of commercial bank reserves engineered by the United States Federal Reserve and the European Central Bank (ECB)...
If financial investors are worried that inflation will eventually begin to rise, there is an easy and straightforward way for them to profit: sell 30-year Treasury bonds, and buy 30-year Treasury inflation-indexed TIPS.
If anything happens to raise real interest rates, your losses on your TIPS will be offset by your gains on the 30s you are short, and you will be fine. If anything happens to lower real interest rates, your losses on the 30s that you are short will be offset by your gains on your TIPS, and you will be fine. But if inflation goes up, the cash flows you we on the 30s you are short stay the same and the cash flows the Treasury pays you on tyour TIPS go up, and you profit.
Buying TIPS and shorting 30s is a way of hedging against inflation risk and inflation risk alone.
"[F]inancial investors [who] are increasingly worried that inflation will eventually begin to rise" would be doing more of this buying TIPS and shorting 30s, and we would see the gap in price between TIPS and 30s rise.
Have we? No.
Breakeven inflation for the 30 year TIPS continues the fluctuate between 2.0%/year and 2.5%/year.
Now you can argue that financial investors are being silly, or short-sighted, or foolish, or irrational, or all four in failing to fear that inflation will rise eventually--and I do argue that. But we can read whether financial investors as a group fear rising inflation off of the spread between the 30 and the TIPS. And they don't.
Why make assertions about what financial investors are doing that are (a) contrary to fact, and (b) easily checked? Where is the profit in that?
One of the great things about economics is that prices can often be used to tell us what people are thinking--what they fear, and what they hope for. Why throw that information away?
