TIPping Off Higher Yields

Ah you're breathing faster
Silence the only sound
There's no need to be nice on the way up
'Cause you're not coming down
--Genesis

After a pullback lasting about two months, 10 Year yields are suddenly striding back toward previous highs. Perhaps the recent pullback has been a classic rest period in order to build energy prior to a new leg higher.

Here's an interesting chart below that suggests motivation for the persistent 'bid' in yields. The red line plots the ratio between the TIP and IEF bond ETFs. Because TIPs (Treasury Inflation Protected Securities) are adjusted for inflation, higher inflation expectations increase demand for them, thus elevating the price. Unprotected Treasuries, such as those in the IEF basket, should not benefit from higher inflation expectations and in fact may experience outflows under such circumstances. Thus, uptrends in the TIP:IEF ratio should signal higher inflation expectations among bond investors.

The white line in the graph is crude oil. Note the trend higher in the TIP:IEF ratio since early 2016. More importantly, note the strong correlation between this ratio and the price of crude. Although the price of crude can change for many reasons, one important factor is the extent to which investors think a depreciating dollar will require more greenbacks to be surrendered to purchase a barrel of oil.

If expectations of lower purchasing power of the dollar is increasing prices of commodities like crude, then perhaps bond investors are beginning to demand higher yields to fairly compensate them for holding Treasury paper.

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