Obamacare Wins U.S. Bond Converts as Slowing Costs Tame CPI

Regardless of what Americans think about Obamacare, reining in health care costs is winning the support of investors in U.S. Treasuries.

After doubling in the past two decades, medical expenses rose less last year than at any time since Harry S. Truman was president in 1949, helped by Medicare reimbursement cuts. The rollout of President Barack Obama’s signature 2010 law will hold down consumer prices for years to come as millions of Americans obtain coverage under the Patient Protection and Affordable Care Act, BNP Paribas SA and Credit Suisse Group AG said.

Less inflation, which boosts the purchasing power of fixed- rate payments, may help attract buyers to Treasuries as the economy strengthens and the Federal Reserve pares its own bond buying. While yields have fallen this year, the compensation 10- year notes provide after inflation is close to the highest in five years. Excluding food and energy, health care accounted for about a third of the slowdown in consumer prices, which rose 1.1 percent in the past year from 2 percent in the prior 12 months.

“This is good news” for bonds, Kathy Jones, a New York- based fixed-income strategist at Charles Schwab & Co., which has $2.25 trillion in client assets, said in a telephone interview on April 4. By holding costs down, “it may be a benefit to inflation, longer-term.”

Jones, who has been advising clients on the bond-market implications of the health-care law, is recommending that investors buy 10-year Treasuries because low inflation will keep the Fed from lifting interest rates.

More Attractive

Costs for medical care increased 2 percent last year, the smallest gain in 65 years, according to data compiled by the Labor Department. Price increases eased as Medicare reimbursements were cut under last year’s budget sequestration and Americans gained access to more generic drugs.

In the two decades before the financial crisis, health-care expenses rose at more than twice that rate on an annual basis.

The slowdown in medical expenses has helped curb inflationary pressures, with living costs rising 1.48 percent in 2013, the least during an expansion in 39 years.

“Inflation is already very low, so having one more category that lowers it even more makes nominal Treasuries even more attractive,” Aaron Kohli, an interest-rate strategist at BNP Paribas, one of 22 primary dealers that trade with the Fed, said in an April 10 telephone interview from New York.

‘Notable Role’

Consumer prices in March rose 1.5 percent from a year earlier and increased 0.2 percent from the previous month, according to government data released today.

Using the Fed’s preferred gauge of inflation, known as the personal consumption expenditures deflator, or PCE, health care is having an even greater impact in containing prices.

Because medical spending accounts for 17 percent of PCE inflation as its second-largest component, slower growth in health care may delay the Fed’s eventual move to lift the benchmark rate that it has held close to zero since 2008, said Martin Hegarty, the New York-based head of inflation-linked bond portfolios at BlackRock Inc., which manages $3.86 trillion.

The slowdown in medical inflation means “PCE is going to be lower” than CPI, Hegarty said by telephone.

Inflation has remained below the Fed’s 2 percent target for 22 straight months and “a couple” of policy makers said at its March meeting that “unusually slow growth” in health-care prices has played a “notable role” in holding back prices, minutes of the gathering released on April 9 show.

Real Yields

February’s 1.1 percent core PCE matched January as the lowest since March 2011. Including food and energy, inflation was even weaker, eased to 0.9 percent from a year ago.

The slowdown, which has frustrated Fed Chair Janet Yellen’s efforts to lift inflation, has made Treasuries more appealing.

While forecasters predicted yields on 10-year Treasuries would rise this year to end at 3.44 percent, borrowing costs have fallen even as the Fed began curtailing its stimulus after spending more than a half-trillion dollars buying U.S. debt in 2013. Yields on the 10-year note decreased from a 29-month high of 3.05 percent in January to 2.65 percent yesterday.

They were at 2.62 percent as of 10:28 a.m. in New York.

Although that level is almost 2 percentage points below the two-decade average, they still offer returns that are close to the highest since 2009 relative to inflation. Real yields are now 1.72 percentage points higher than PCE, versus 1.21 percentage points on average in the past five years.