July 14, 2017 / 6:36 PM / 8 days ago

UPDATE 1-Investors' U.S. inflation view deflates as CPI misses again

3 Min Read

(Adds background, details on latest data, adds quote, updates market action)

By Richard Leong

NEW YORK, July 14 (Reuters) - Investors' inflation expectations took a hit on Friday as the government's consumer price index fell short of analysts' forecasts for a fourth straight month, pulling it further away from the Federal Reserve's 2-percent goal.

Another weak CPI reading stoked concerns about whether the U.S. central bank would raise short-term interest rates for a third time in 2017.

With little evidence of upward price pressure in the economy, Treasury Inflation Protected Securities (TIPS), whose payments to investors are adjusted against the CPI, lagged regular Treasuries after the government said CPI was unchanged last month, compared with a 0.1 percent gain forecast among analysts polled by Reuters.

"The Fed is moving further away from its (inflation) target," said Fred Marki, portfolio manager at Western Asset Management Co. in Pasadena, California. "Even when we had some better growth earlier this year, it didn't feed into inflation."

Back in February, year-on-year CPI reached 2.7 percent, which was the biggest increase in five years before cooling to 1.6 percent in June, which was the smallest gain since October 2016.

Investors' inflation expectations, measured by the yield difference between TIPS and regular Treasuries, have contracted 35 basis points as the CPI retreated on lower prices on gasoline and mobile phone services.

In late trading, the 10-year inflation breakeven rate, or the yield gap between 10-year TIPS and benchmark 10-year Treasury notes, was 1.77 percent, down 0.5 basis point from Thursday, according to Tradeweb and Reuters data. .

The 10-year breakeven rate had fallen more than 3 basis points shortly after the June CPI report.

It pared its losses as regular Treasury yields bounced off their session lows and a report from the University of Michigan that showed a rise in consumer inflation expectations in early July.

Year-to-date, TIPS produced a total return of 0.77 percent, less than the 1.68 percent gain on regular Treasuries, according to indexes compiled by Bloomberg and Barclays.

While another weak CPI reading further diminished the TIPS' prospects, investors are not ready to abandon the sector.

TIPS-focused funds have enjoyed consistent inflows despite the softening in inflation. Their assets grew to $63.2 billion in the week ended July 12, which was the most going back nearly 15 years, according to Lipper, a Thomson Reuters unit.

"We are not going to see a body blow to the TIPS market," Western Asset's Marki said. "TIPS might hold their own in the next quarter or two." (Reporting by Richard Leong; Editing by Chizu Nomiyama and Diane Craft)

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