Sign that bond market backs 3rd quantitative-easing round? Check Huggies’ price.

February 11, 2012

Procter & Gamble’s failure to raise the price of Cascade dishwashing soap shows why investors are buying Treasuries at the lowest yields in history, giving the Federal Reserve more scope to boost the economy.

The world’s largest consumer-products company rolled back prices after an 8 percent increase lost the firm seven percentage points of market share. Kimberly-Clark started offering coupons on Huggies after shoppers resisted the diapers’ cost. Darden Restaurants raised prices at less than the inflation rate as patrons ordered more of Olive Garden’s discounted stuffed rigatoni than it anticipated.

Low inflation has continued to boost demand for Treasuries, keeping rates down as President Obama finances a $1.1 trillion budget deficit to boost an economy still growing at rates below the 20-year average. The Fed set an annual inflation target of 2 percent two weeks ago, and policymakers suggested they may conduct QE3, a third round of bond purchases under a policy known as quantitative easing.

“Any way you look at it, the Treasury market is still expecting rather benign inflation, and we will be in a low-rate environment for some time,” said David Ader, head of U.S. government bond strategy at CRT Capital.

Companies can’t raise prices because wage growth remains stunted even though unemployment has started to recede. Average hourly earnings rose 1.9 percent in January from a year ago, the smallest increase since April. The jobless rate fell to 8.3 percent last month, the lowest level in three years.

“This recovery has not been a great recovery with regard to income gains, and income gains are a function of both growth in wages and jobs,” said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock. “Why can’t you pass price increases through to consumers? It’s because consumers aren’t seeing income gains.”

BlackRock, which manages more than $1 trillion in assets, favors corporate, municipal and mortgage bonds, the firm said last month in a report.

The consumer price index will rise 2.1 percent this year and next, according to a Bloomberg survey. A bond market measure used by the Federal Reserve to forecast inflation starting five years from now fell to 2.50 percent from last year’s high of 3.23 percent in August and less than the average of 2.76 percent in the past decade.

The yields on the benchmark 10-year note remain below their average of about 5.28 percent since 1990 even as Treasury sells record amounts of bonds to finance the federal deficit. The United States will spend about 3.1 percent of gross domestic product servicing its $15.2 trillion of public debt, less than the 4.8 percent when President George H.W. Bush was in office, according to Office of Management and Budget and International Monetary Fund data.

Subdued inflation and growing demand for safe assets as Europe’s sovereign debt crisis intensified helped propel returns on Treasuries to 10 percent, including reinvested interest, in the 12 months ended Jan. 31. Last year’s gain of 9.8 percent as measured by Bank of America Merrill Lynch indexes beat the 2.1 percent gain in the Standard & Poor’s 500-stock index, including dividends.

While yields rose last week, they are down from Jan. 24, the day before the Fed said it would keep its benchmark interest rate in a range of zero to 0.25 percent until at least 2014, a year later than planned, lowered its growth forecast and for the first time set 2 percent as its inflation target.

“There are lots of global and domestic headwinds, and the Fed is less concerned about inflation than they are making sure the economy is taking hold,” said Scott Graham, head of government bond trading at Bank of Montreal’s BMO Capital Markets unit in Chicago. The firm is one of the 21 primary dealers that trade directly with the Fed.

Low bond yields make investors more susceptible to losses if inflation and interest rates climb. Ten-year-note yields are expected to rise to 2.19 percent by mid-2012 and 2.57 percent by the end of the year, according to the weighted average in a Bloomberg News survey of more than 60 economists and analysts.

Investors, except for those owning 30-year bonds, are accepting negative yields after taking into account the consumer price index, a sign they may expect inflation to slow. Ten-year notes yield 1.08 percentage points less than the consumer price index.

“Inflationary or wage pressures will probably start to build at a higher unemployment level than they would have in the last decade,” said Scott Minerd, chief investment officer of Guggenheim Partners, which oversees more than $125 billion.

The central bank printed money and bought $2.3 trillion in Treasury and mortgage-related bonds between 2008 and June 2011 to support the economy in two rounds of quantitative easing.

Federal Reserve Board Chairman Ben S. Bernanke said Jan. 25 that he’s considering another set of purchases. Economists in a Bloomberg News survey the same day estimated the central bank will buy mortgage bonds should the economy warrant more stimulus, with purchases of all types totaling $500 billion.

Inflation as measured by the personal consumption expenditures index, excluding food and fuel, the measure used by the Fed for its forecasts, rose 1.8 percent in the fourth quarter from a year earlier. That’s down from more than 2.5 percent as recently as 2008.

The Fed at its Jan. 25 meeting cut its forecast for growth this year to 2.2 percent to 2.7 percent, from a projection of 2.5 percent to 2.9 percent in November. It predicted the economy will expand 2.8 percent to 3.2 percent next year, down from the previous 3 percent to 3.5 percent.

P&G, the maker of CoverGirl cosmetics and Duracell batteries, took advantage of low inflation and interest rates Feb. 1 when it sold $1 billion in 10-year, 2.3 percent bonds at the lowest coupon on record for corporate securities of that maturity.

The offering came less than a week after the company said that market-share loss in dishwashing soap “is not something that we are willing to accept, and we have taken corrective action.” P&G “will be reversing our pricing increase on the Cascade business,” said Teri List, vice president of corporate accounting.

Kimberly-Clark said fourth-quarter profit fell 18 percent on slowing demand in developed markets where the company is struggling to make some price increases stick. The Dallas-based maker of Kleenex tissues and Scott paper towels said it issued more coupons in North America on goods, including Huggies Little Movers Slip-On diapers and potty-training pants, soon after raising prices.

Darden is limiting price increases to 3 percent even as commodity prices soar. It’s emphasizing “affordability” in promotions such as a “Never Ending Pasta Bowl” for $8.95. “There was more trading to the lower-priced promoted entrees than we have seen historically,” said chief operating officer Andrew Madsen.

Most U.S. central bankers expect inflation of 1.4 percent to 1.8 percent this year, down from the 1.4 percent to 2 percent range they forecast in November, the Fed said.

“The market,” Ader said, “is still skeptical that the Fed will be able spark inflation expectations significantly.”

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