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Global Macro: 2013 a Bad Year for TIPS

NEW YORK (TheStreet) -- Falling prices for TIPS as measured by the iShares Barclays TIPS Bond Fund (TIP) signal investors are losing confidence that central banks can spur inflation.

2013 is set to be the first year since the creation of the index in 1997 that TIPS prices will close lower for the year as November's inflation number was the lowest monthly reading in the U.S. since 2009.

TIPS stand for Treasury Inflation Protected Securities. They are securities indexed to inflation and are used by investors as protection against higher inflation.

With expectations for inflation to remain low and the prospect of the Federal Reserve reducing its bond purchases, the question of when will inflation return to more normal levels is coming back.

The first step toward increased inflation readings is for prices to actually rise, not just for expectations to improve. Previously, since the inception of quantitative easing, inflation expectations had been rising steadily.

At the beginning of 2013, however, those expectations became less credible. Central banks across the globe had embarked on unprecedented stimulus measures, and yet prices didn't move meaningfully higher.

As the dollar began to strengthen against the yen at the beginning of the year, both gold and TIPS sold off heavily. On a monthly chart, it even looked as if the cyclical bull market in gold had finally reached its peak. The lack of credible inflation fear was dragging TIPS down as well.

The issue with inflation isn't a lack of effort by central banks, but rather that the stimulus strategy has been undermined. As borrowing rates have decreased, companies have bought back shares of their own stock. That has improved earnings per share, but has created very little value to the company as a whole.

Similarly, record-breaking corporate productivity has put more emphasis on investment in software innovations as opposed to labor and capital investment. That has led to an unequal recovery where companies have come back strong and equity valuations have grown exponentially at the expense of a still crowded unemployment market.

The lack of labor participation in the recovery has caused the recovery itself to be more gradual, as opposed to the more robust growth that the Fed prefers.

When it became clear in October that Janet Yellen would be the next Fed chairman, TIPS spiked higher. Investors hoped her new regime would continue to fight a battle against low inflation.

Even European Central Bank President Mario Draghi said in November that he was cutting rates because of a prolonged expectation of low inflation.

The market made it clear in 2013 that expectations are no longer good enough. The only way that inflation will be credibly feared is if it actually shows up in the data. TIP ChartTIP data by YCharts

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Stock quotes in this article: TIP 

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