Safe havens against stagflation

abnormalreturns
March 4th, 2008

The markets are currently dealing with any number of cross-currents. One need only look to the fixed income markets to see how fears of stagflation are playing out in real time. Investors in search of a safe haven against stagflation are rapidly running out of options.

First, yields on the five-year TIPS are now below zero! In short, investors desperate for a “safe” way to play higher inflation have bid the bonds to levels not previously seen. (via Calculated Risk and naked capitalism)

Second, the slope of the Treasury yield curve continues to steepen. While long term interest rates have dropped, the shortest term rates have been in a virtual freefall. This is due in part by fears of incipient inflation. (via Crossing Wall Street)

Third, fears of an economic slowdown continue to affect the high yield credit markets. By one measure, high yield bond spreads have jumped to levels not seen since early 2003. (via Bespoke Investment Group)

In closing, John Authers at FT.com notes the contradiction of investors bidding up both bonds and commodities simultaneously.

Over the past 25 years, stagflation – inflation combined with a recession – has been avoided. Traders are buying commodities as a hedge against inflation and thus, implicitly, predicting stagflation.

Higher commodity prices guarantee upward pressure on inflation. But the slowdown predicted by stocks and bonds reduces commodity demand. So buying commodities to hedge against economic woes looks like a self-defeating strategy.

Safe havens against the perils of stagflation are few and far between. The obvious ones, like TIPS, have already been bid up to seemingly unsustainable levels. No one said this investing business was going to be easy.