UBS Inflation-Linked Strategy - Euromoney Conferences

TIPS should now trade cheap to fair value
Two ways this can change
1. The ‘fair value’ shifting higher once again
♦ This would reflect an aggregate increase in investor concern about inflation; we
would argue that there remains a polarised lobby within the investor base.
♦ Further, the economic recovery is still not strong enough to justify excessive
inflationary concerns (especially with the current slack in the labour market).
♦ Hence, near-term we see the 2.5% US CPI ‘fair value’ concept as being justified
♦ Nevertheless, we are in the inflation camp and hence can see a move higher in the
fair value at some stage in the future
2. Mean-reverting type investors come back into the market
♦ This occurred in the previous economic cycle (2004). In our view this was driven by
a) increasing liquidity in the inflation-linked bond asset class
b) breakevens cheap to fair value in the prior years (1999-2003). So the
cheapening of breakevens to fair value can be seen as almost a pre-condition
for these investors to return – this could well be the story at some stage this
year, but no yet
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