The U.S. government shutdown has caused a "data vacuum" in the market, prompting the activation of the inflation-linked securities backup mechanism.

In the $7 trillion market, traders are facing an unprecedented situation: they have to price securities linked to US inflation without any Consumer Price Index (CPI) data available. With the US government shut down since the beginning of the month, this data gap could continue, especially after the White House indicated that the US may not release October inflation data. This has prompted investors to activate the "fallback mechanisms" embedded in inflation-linked bond and derivative legal documents from decades ago, these untested mechanisms have now become alternative solutions. These contingency plans were originally designed for "tail risk" (low probability, high impact risk), and until recently, considering the systemic importance of US economic data, such risks were unimaginable. The inflation rate in the US is embedded in various financial contracts, and the monthly data releases shake global markets and influence the Federal Reserve's monetary policy direction. More complicated is that not all inflation-linked securities use the same fallback mechanisms. The calculation method used for the $2 trillion US Treasury Inflation-Protected Securities (TIPS) differs from that used in the $5 trillion inflation swap market the latter being a tool for investors and companies to hedge against rising prices. This difference has led to a strong performance of a TIPS maturing in January 2025, as the market expects it to possibly bring higher returns. The longer the government shutdown lasts, the more distorted this market for "investors hedging against inflation, policymakers measuring inflation expectations" will become. Barclays Bank's Jon Hill, head of US inflation strategy, said: "The differences in fallback mechanisms could lead to interesting divergences. As the shutdown continues, this is undoubtedly an area of concern for the inflation market, and it provides evidence for potential relative value opportunities." The fallback calculation method for TIPS is determined by the US Treasury Department. If October CPI data is missing, the Treasury Department will publish a synthetic number based on the "most recent 12-month change in CPI available" (i.e. data from September 2024 to September 2025). For zero-coupon inflation swaps, standard contracts follow the International Swaps and Derivatives Association (ISDA) guidelines. If the derivative is not linked to specific bonds, ISDA's fallback calculation method will be based on October 2024 CPI data, then adjusted with the year-on-year increase in September 2025 to derive the result. The current US government shutdown has become the second-longest in the country's history, and as investors continue to operate "blindly," the shutdown threatens to exacerbate the distortions in the market mentioned above. While the Bureau of Labor Statistics was allowed to recall some staff to compile the September CPI report, all current data collection work has been halted, disrupting not only the release schedule for October data, but potentially affecting future data as well. The use of fallback mechanisms has a special impact on the interest and principal payments due in January 2025 for TIPS. According to Treasury Department regulations, investors' earnings on January 15th each year must be calculated through interpolation using the CPI figures for October and November. However, calculations show that there will be differences in the final results based on different calculation methods. For example, based on the October data, the index reading from the TIPS fallback mechanism is 325.604, higher than the 325.174 from the inflation swap fallback mechanism; if November data is also missing, the gap between the two will widen further with the TIPS reading at 326.411, and the inflation swap at 324.998. Barclays Bank's calculations show that if both October and November CPI data are missing, the annual breakeven rate for the TIPS maturing in January 2025 will reach 3.15%, while the ratio for the inflation swap for the same period will be only 1.76%. Hill pointed out: "There is a huge discrepancy between the breakeven rates for TIPS and the inflation swaps for the same period." A strategy team led by Jay Barry at JPMorgan Chase & Co. stated that considering the possibility of fallback mechanisms being activated in October, this TIPS maturing in January has already seen relative strength; if November CPI data is also unlikely to be released, this strength trend may further continue. The team stated: "If the shutdown extends for more weeks (a possibility that seems to be increasing), securities like these may strengthen further."