Pinpoints: The Scramble for Inflation-Linked Bonds

Federal Reserve Policy & Inflation Expectations
Federal Reserve Policy & Inflation Expectations

Battling over inflation rates

--In these times of austerity, no stone of fiscal policy is left unturned; lately,it's once-wonky price indexes which have found themselves at the center of heated policy debates on both sides of the Atlantic.

--The U.S., during fiscal-cliff negotiations, floated a shift to using the chained consumer-price index for Social Security payments in place of the headline index in order to save taxpayers money over time; this was met with stiff resistance by those wary of the cut it could imply for lower-income older Americans who rely on Social Security, but is likely to resurface in future rounds of talks.

--The U.K., meanwhile, was today expected to tweak its retail-price index methodology to remove an "upward bias" in this RPI rate which is the benchmark for the inflation-linked government bond market, in order to save money. Surprisingly,however, the Office of National Statistics decided to leave the calculation unchanged, bringing "significant benefits to the holders of these[inflation-linked] assets," notes Goldman Sachs. The principal loser, the firm adds, is "the UK Treasury, which will miss out on an estimated 2-3 billion in savings had the change been made."

Lickin' fingers for inflation-linkers

--Just how much of a win was it for bondholders? Demand for inflation-linked gilts jumped on the news, pushing yields to a fresh record low of -0.97 percent, compared with the prior session close of -0.63 percent. "It seems likely that the threat of a raft of legal challenges left the ONS no option other than to make this smaller-than-expected change," Marc Ostwald of Monument Securities told Reuters.

--Who's buying? "ONS data shows the [UK] domestic pension and insurance industry shedding nominal gilts (accompanied by foreign buying) in favour of index-linked gilts over the past two years," notes HSBC. In other words, a growing share of UK Treasury payouts in the years ahead will go to UK pensioners; a generational struggle between future taxpayers and pensioners, in the absence of a sharp pickup in growth, seems inevitable.

--And not just in Britain. Bill Blain meanwhile points to Pimco's warning on inflation risks in the U.S. and Japan, and proclaims: "Inflation linked bonds are shaping up to be one of the themes of 2013."

Cyprus: Alive at five?

--The tiny island joined the euro zone on January 1, 2008; now, it has supplanted neighboring Greece as the monetary bloc's weakest link and flash point for its woes. Size, here, doesn't matter; Cyprus accounts for just 0.2 percent of euro zone GDP. As with Greece, what matters is precedent. How policy makers handle Cyprus indicates how they will (or won't) handle other struggling nations, and the progress (or lack thereof) on furthering euro zone integration, and allaying break-up fears.

--"Cyprus's hopes of agreeing a euro zone bailout were thrown into fresh confusion on Wednesday as German politicians from across the spectrum warned that the aid package could be vetoed by the Bundestag," writes theGuardian.The market's concern? "[The package] would most assuredly be voted down due to the belief that Cyprus is just a tax haven for Russian oligarchs," says FX360's Neil Gilbert (who last year floated the acronym SICPIG to account for the country's troubles). "If reporters begin asking questions about this issue,shining light on the situation, and the market doesn't like Draghi's response,it could be the beginning of a long term unwinding of the confident euro trade."

—By CNBC's Kelly Evans; Follow her on Twitter: @Kelly_Evans