UBS Inflation-Linked Strategy - Euromoney Conferences

TIPS should now trade cheap to fair value
How important is the breakeven?
Breakeven (%)
Generic 10-year TIPS breakeven history
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
Non mean
reverting
environment
97 98 99 00 01 02 03 04 05 06 07 08 09 10
♦ In inflation-linked space there is an additional factor : the breakeven rate is a perfect vehicle for
mean-reversion type trading
♦ While mean-reverting investors are almost entirely focused on the breakeven variable, non-mean
reverting are focused on both the breakeven and real yield. For example, long-term liability
investors can be seen to be real return focused and hence will invest primarily based on the real
yield level
♦ Higher TIPS turnover equates to dominant involvement by leveraged investors (i.e. mean-reverting
type investors); whereas lower turnover environment reflect real money based investors being in
the ‘driving seat’
♦ In our view, we are back into a non mean reversion environment and hence 10-year TIPS
breakevens should, on average, trade cheap to fair value (i.e. around 2% rather than 2.40%)
Source: Bloomberg, UBS
Mean reverting
environment
Generic 10y TIPS BEI
?
5%
4%
3%
2%
1%
0%
Turnover data for TIPS (uplifted basis)
98 99 00 01 02 03 04 05 06 07 08 09 10
Turnover per uplifted amount outstanding (face amount x IR),
8-week avg
5