US inflation expectations have fallen to their lowest level since November, with an important investor benchmark back in negative territory for the year and money fleeing exchange traded funds that follow the asset class.

The shakeout in the inflation market comes as commodity prices, led by gold, have slumped, and consumer prices for March published on Tuesday were lower than forecast.

While inflation expectations picked up late last year as the Federal Reserve launched open-ended purchases of bonds, and the Japanese election result foreshadowed far more aggressive easing from the Bank of Japan, investors are now worried about falling inflation in the near-term.

Market expectations for US inflation over the next 10 years have eased to 2.40 per cent, down from a peak of 2.60 per cent in March, based on the difference or the so-called “break-even rate” between nominal and inflation-protected Treasury debt.

Inflation expectations for the next five years have fallen 30 basis points in the past month to about 2.10 per cent.

“The overall decline in commodity prices has increased the markets’ perception of potential disinflation emerging,” said James Evans, senior vice-president at Brown Brothers Harriman. He said short-term bond funds holding Treasury inflation protected bonds, known as Tips, which have been popular among investors, are set to substantially underperform other assets.

An index of Tips, including bonds up to a maturity of five years, was back in negative territory for the year on Monday in terms of its total return, according to Barclays. An index of the broad Tips market remains 0.4 per cent higher on the year, but lags behind the return on nominal Treasury bonds.

Outflows from the iShares Barclays Tips ETF have reached $1.7bn to date this year, nearly double the $890m that was pulled during all of 2012 according to IndexUniverse. Overall, investors have withdrawn $2.8bn from mutual funds that buy the securities through March, the longest period of outflows since the end of 2008, according to Morningstar.

The adverse fund flows and performance may persist given the allure of Tips as an inflation hedge for many investors since the Fed upped its quantitative easing efforts late last year.

“Inflation break-evens have already moved significantly lower but with many investors long Tips for seasonal reasons and yet to liquidate, we do think that break-evens have further downside,” said Richard Gilhooly, a strategist at TD Securities.

A test of investor sentiment looms on Thursday with the Treasury selling a record $18bn of five-year Tips.

“That will focus the mind as to whether to add to inflation at lower levels or demand a deeper concession,” said Mr Gilhooly. He added that 10-year break-evens are likely to trade well below 2.40 per cent, “before we find them attractive, especially as this move is occurring amid stepped-up global quantitative easing”.

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