The $2 trillion bond market is in crisis, and the risk of delaying the US CPI is comparable to the US debt ceiling crisis

The ongoing shutdown of the U.S. government is pushing the $2 trillion Treasury Inflation-Protected Securities (TIPS) market into unprecedented territory.

On October 24, Wall Street Insight reported that the White House stated that due to the government shutdown, the U.S. government may be unable to release the inflation data for October. This will directly impact the TIPS and inflation swap markets.

Since TIPS are adjusted based on the Consumer Price Index (CPI), their interest payments are also linked to this index. The absence of data means the market will lose its pricing "anchor."

Data shows that some exchange-traded funds (ETFs) investing in TIPS have recently experienced capital outflows, while the performance of TIPS has also lagged behind that of regular U.S. Treasury bonds.

Jonathan Hill, head of U.S. inflation strategy at Barclays Capital, described the current situation facing the TIPS market as comparable to the "debt ceiling crisis," an event that all market participants must closely monitor.

If the CPI data for October ultimately goes missing, the market will not only activate the "backup plan" established for TIPS and inflation swaps for the first time, but the turmoil caused by the quality of the data itself may also follow.

First Test of the "Backup Plan"

The operational mechanism of the TIPS market makes its dependence on CPI data extremely direct.

These securities have lower coupon rates than regular Treasury bonds, but their principal is adjusted according to CPI changes, providing investors with inflation protection.

The CPI value determines the interest payments on TIPS with a two-month lag. Therefore, the government shutdown that began on October 1 has already delayed the release of September's CPI data from the originally scheduled October 15 to last Friday, but it has not triggered the extreme situation that requires the established "backup plan."

However, Barclays' Jonathan Hill pointed out that if the October data cannot be released, the situation will change completely. Hill stated:

If the October CPI data is still not released by the end of November, the backup plan will take effect.

According to the U.S. Code of Federal Regulations, when CPI data for a given month (M) is missing, the Treasury will use an estimated value. This estimate is based on the CPI changes over the past 12 months. This estimated index will be used to calculate the principal adjustments and interest payments for the current TIPS.

Crucially, once this alternative plan is activated, the calculated results will be final, and even if the Bureau of Labor Statistics (BLS) later releases the actual CPI data, this estimate will not be retroactively revised. This mechanism is designed to ensure that TIPS payments can continue during special periods such as government shutdowns.

He emphasized that this will not only affect TIPS but will also impact the inflation swap market. Hill lamented:

This is an unprecedented situation.

Concerns Over Data Quality Have Impacted Investor Demand

Even if the data is eventually released, quality issues may still trigger market fluctuations.

The White House acknowledged in a statement last Friday that the disruption of government funding is hindering price surveyors from doing their work.

The strategist team at Morgan Stanley, led by Aryaman Singh and Matthew Hornbach, believes that concerns over data quality can explain the recent weak performance of the inflation-protected bond market. They wrote in their report:

As the quality of CPI data deteriorates, investors believe they cannot obtain an effective hedge against true inflation, leading to a decline in demand for inflation-protected bonds.

The report also presented another perspective:

Due to poor data quality, inflation-protected bonds require a higher term premium compared to regular government bonds.

This is directly reflected in market performance, as inflation-protected bonds have lagged behind nominal government bonds since mid-July.

The Market Has Not Fallen Into Panic

Despite the uncertain outlook, the market remains relatively restrained at present.

Some analysts believe that the weak performance of inflation-protected bonds has a broader context. For example, the decline in oil prices has led retail gasoline prices to drop to their lowest level since December last year, while gasoline accounts for about 3% of the CPI, which itself suppresses market demand for inflation protection.

Additionally, the recent outflow of funds from inflation-protected bond-related ETFs has not yet posed a substantial impact on the size of these large funds. Investors relying on these products for liquidity may not necessarily flee in large numbers in the short term.

Barclays' Hill also stated that unless the data interruption issue "becomes systemic," it does not pose a significant threat to the market.

Gang Hu, a market expert on inflation and managing partner at Winshore Capital Partners, believes:

As long as price data can remain free from political manipulation, I don't think this will change the overall situation.

However, he also warned:

If the situation deteriorates to that extent, we may first need to address some larger issues before considering whether people will still buy inflation-protected bonds