All out war in the Commodity prices

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aWiA2eAsiFyo

You may read the above for the complete article. (I think the hedgefunds/trade groups paying for this publication is starting to get backing in DC and elsewhere politically as things are really getting hairy for the power that be, from what I have heard)

I am 90-95% in agreement with the hedgefunds supplying this article to Bloomberg, with one small caveat in the sense that this pertains only to marginal buyers of Treasury.

If you are the oil producers and therefore hedged for the Cost of Energy by getting it for free, you are only asking for CPI-nonfood/energy for compensation, if you MUST recycle the money back into the US currency. That is also why in addition to the Chinese angle, you must think of the marginal buyers as "bulk" buyers with no current alternative. The market itself may already be 100% in agreement with the story and demand higher compensation for TIPS were it not for those guys.

Also, the article is not right to say the the Consumer Expectation of Inflation is only "tracking inflation" better than CPI. It is very dead on. CPI is a 3-month number and by definition, "averaged out" relative to the spot number (the Consumer Expectation).

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TIPS Show Bonds See Bubble Burst for Commodity Prices (Update2)
By Sandra Hernandez

May 19 (Bloomberg) -- Treasury bond traders are telling Americans to stop fretting about inflation.

Consumers expect prices to rise 5.2 percent in the next 12 months, according to a monthly survey by the University of Michigan in Ann Arbor, the most pessimistic they've been since 1982. Treasury Inflation Protected Securities, or TIPS, show traders anticipate inflation of about 2.9 percent by January, in line with its average of 3.1 percent the last 20 years.
The disparity has never been wider. While consumers grapple with gasoline above $3.70 a gallon, record rice prices and the escalating cost of wheat, TIPS say the commodities market is a bubble about to burst. A commodity slump would worsen losses in the $500 billion TIPS market, where investors lost 2.35 percent in April, the most since December 2006.

``There's a lot of people who just don't believe the economy's going to stay strong enough to keep prices of things where they are,'' said Chris McReynolds, who trades TIPS in New York at Barclays Plc, the largest dealer of the securities. ``Part of what's going on here is a lot of people view this price rise in oil, a lot of commodities, as being somewhat bubbleish and that they'll come off again very quickly.''

`Imminent' Downturn

``What has not been going up is housing prices, what has not been going up is electronics, what has not been going up is apparel,'' said Gang Hu, a TIPS trader at Deutsche Bank AG in New York. Consumers ``buy food everyday, they buy gas everyday. As a result, if you ask them have you seen inflation, they will say yeah, because every day they are informed there is inflation.''
Short-maturity TIPS have the most to lose from an ``imminent economic downturn,'' Hu said.
Before this year, the public and the TIPS market were most at odds in June 2007, with consumers projecting 3.4 percent inflation and TIPS forecasting a 1.48 percent rate. Consumers have been right: inflation has averaged 4.1 percent this year.
Consumers are responding to a jump in the cost of food and oil, even as prices of less-frequently purchased items like cars, plane tickets and hotel rooms fall.
$56.25 for Gas

American drivers pay a record $56.25 on average each time they fill their tanks, according to figures provided by AAA, the largest U.S. motorist organization. Meanwhile, new cars cost 1.3 percent less than a year ago, and plane tickets were 0.5 percent cheaper in April, according to the Labor Department. Energy makes up 9.7 percent of the consumer price index, and commodities as a category comprise 41 percent, behind only services such as housing and medical care.

The economy won't grow at all this quarter, marking the worst slowdown since the 2001 recession, according to a Bloomberg News survey of 80 forecasters. Inflation will slow to 2.5 percent by the first quarter of 2009, the least since August, according to a separate poll.
TIPS, first issued by the government in 1997, pay interest at lower rates than Treasuries on a principal amount that's linked to the Labor Department's consumer price index. The yield on the benchmark 1 5/8 percent security due in January 2018 rose 1 basis point last week to 1.37 percent and was little changed today.
TIPS due in January yield 2.95 percentage points less than regular Treasuries of similar maturity, compared with an average of 2.03 percentage points the past year.

Breakeven Rate

The difference, known as the breakeven rate, is the pace of inflation traders expect over the life of the securities. The disparity with public projections has never been wider. Because the government doesn't sell TIPS of less than five years, TIPS with one year left to maturity didn't appear until 2001.

Consumers and TIPS traders both influence Federal Reserve policy makers, who study the two groups' inflation expectations when making interest-rate decisions, said Brian Sack, a former research manager at the central bank. He is now a senior economist with Macroeconomic Advisers LLC in Washington.

The Fed's decisions are more complicated when the two groups are ``giving different signals,'' Sack said. ``The measures carry more weight when they're all moving in the same way and telling a similar story.''

In Agreement

The last time the two groups were in agreement was April 2006. Households surveyed by the University of Michigan that month forecast 3.3 percent inflation for the year, versus traders' 3.28 percent projection. Both projections were too high, as prices rose 2.6 percent through April 2007.

``It's almost ingrained in the psyche of the market that people think ultimately inflation will recede because the economy's slowing down,'' said George Goncalves, chief Treasury and agency debt strategist in New York at Morgan Stanley, one of the 20 primary dealers of U.S. government securities that trade with the Fed.
A weak dollar, record import prices and rising commodities will lift prices of goods besides just food and fuel, meaning traders are underestimating future inflation and TIPS are a bargain, according to Michael Pond, an interest-rate strategist in New York at Barclays. One-year breakevens should be 1.37 percentage points wider than the current 2.94 percentage points, Pond estimated.

``The consumers are more right'' than TIPS traders, said James Evans, who manages $4 billion of inflation-linked bonds at Brown Brothers Harriman & Co. in New York. ``TIPS breakevens have continuously underestimated inflation.'' Evans has been buying TIPS maturing in three to five years.

Regular Treasuries are also pointing to a slowdown in price gains. In the last six months, yields on 10-year notes traded below the inflation rate for the first time since 1980. Over the past two decades, yields averaged 2.87 percentage points more than inflation.