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Bond Market's Inflation Widowmaker Returns in a First Since 2013

The last time the spread between 30- and 10-year breakeven rates turned negative was the taper tantrum.

by Jacob Bourne
(Bloomberg) --In a rush to purchase inflation protection, bond traders are piling into wagers they already know will probably backfire on them.

The demand for Treasury Inflation Protected Securities, known as TIPS, and the relentless flattening of the U.S. yield curve have sent the spread between 30- and 10-year breakeven rates below zero for the first time since 2013. When it turns negative, it’s colloquially referred to as a “widowmaker” trade, because it’s seen as likely to cause quick and sharp losses. Indeed, the last time it happened, the gap widened by more than 25 basis points within three months as the 2013 selloff known as the taper tantrum gripped bond markets.

Yet with signs of quicker inflation emerging, traders are so eager to own TIPS that they’re flooding the most frequently traded 10-year portion of the curve. That explains why the 10-year breakeven rate has climbed more than its 30-year counterpart since December, shrinking the spread between the two.

The inversion shows investors weren’t willing to wait for Thursday’s $13 billion 10-year TIPS auction to get their bonds. There was still plenty of interest in the offering, leaving primary dealers with their smallest share ever, and causing the breakeven spread to turn even more negative. The sale shows growing concern over price pressures after last week’s release of unexpectedly strong consumer-price figures.

Breakeven inflation rates “are cheap, and it’s not surprising given the recent strength in core inflation and the momentum in energy that investors are willing to push intermediate BEIs closer to fair value,” said  Nils Overdahl, a senior portfolio manager at New Century Advisors.

Another factor inverting the breakeven inflation curve is the rally in energy prices. Crude oil is up 50 percent from its lows in June, pushing the consumer price index higher. Shorter-maturity TIPS are more exposed to the main inflation figure, which is partly why breakevens are getting closer to one another.

The latest TIPS auction was widely considered strong by traders and strategists, with the yield coming in lower than indicated before the sale. It means further inversion could be in the cards, and that bond traders might have to get used to a flat breakeven curve as they sort out the Federal Reserve’s inflation mystery.

Breakeven rates “are the only thing that still trade on the cheap side of fair value,” Overdahl said.

To contact the reporter on this story: Jacob Bourne in New York at [email protected] To contact the editors responsible for this story: Benjamin Purvis at [email protected] Brian Chappatta, Mark Tannenbaum

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