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Inflation watchers–just about everyone in the financial markets these days–will focus on Thursday’s auction of $13 billion in 10-year TIPS (Treasury Inflation-Protected Securities) in the search of clues about the direction of inflation.

Or something.

The auction of inflation-protected Treasuries (the value of the principal rises with inflation so holders of these Treasuries are protected from the power of inflation to eat away at the buying power of money) won’t tell us anything about the course of inflation. Prices may be about to spin out of control as the April CPI (Consumer Price Index) inflation numbers argued or the year to year jump of 4.2% in the all-items CPI could, as the Federal Reserve has argued, be a fleeting response to supply-chain breakdowns caused by the pandemic. The results of the auction won’t settle that debate.

But the auction will tell us something perhaps even more important in the short-term and medium-term than the actual trend of the inflation rate. The auction, the first offering of TIPS since an April 22 auction of 5-year maturities, will tell us what the markets and investors expect from inflation. And in the short and medium term its those expectations that will move bond and stock prices.

Cash has been flowing into TIPS and ETFs that invest in TIPS at a rate that reflects rising market worries about inflation. Last week, the five-year inflation breakeven rate jumped to 2.82%. That the highest since 2005. The yield on the 10-year (non-inflation protected or regular) Treasury rose to the highest level in a month.

The Federal Reserve is acting like its trying to manage the TIPS market, which strikes some observers (such as yours truly) as a sign that the central bank is trying to prevent inflation expectations for taking off. On Thursday, May 13, the New York Fed announced plans to reduce the amount of TIPS it will purchase over the next month–that would leave more TIPS available for other buyers. The U.S. Treasury has also announced that it will boost the size and frequency of TIPS auctions in coming quarters. That too would have the effect of increasing supply and to prevent a run up in price.

The April 22 auction of 5-year TIPS had the strongest demand since 2019.

A similar, or stronger auction, would reinforce expectations that inflation is on a march higher.