The European Union is now faced with rising inflation. Investors may hedge against the potential harm of rising inflation to a government bond through Treasury-inflation protected security (TIPS) exchange traded funds (ETFs).
Eurozone inflation for March was a higher-than-expected 2.6% year-over-year, beating a projected 2.3% rise, which could push the ECB to raise the bank’s key rate at its next April 7 meeting, writes Gregory White for BusinessInsider.
ECB policymakers have hinted that the central bank could raise its main interest rate by a quarter of a percentage point from 1%. Many economists blame rising energy costs as a major contributing factor. [TIPS ETFs: Give ‘Em Some Time.]
The surge in inflation has fueled speculation of multiple interest rate hikes to cool the economy, reports Brian Blackstone for The Wall Street Journal. Meanwhile, the euro gained on the news since higher interest rates bolster a currency’s value and the U.S. Federal Reserve isn’t expected to start rate hikes for at least a few more months. [Using TIPS ETFs in Retirement.]
Some economists now project inflation rates close to 3% by summer, above the ECB’s target of below 2% over the medium term. For the last three months, inflation has risen almost 5% at an annualized rate.
Meanwhile, Germany, the region’s largest economy, reported another drop in unemployment, according to Ralph Atkins and Quentin Peel for Financial Times. German data revealed that unemployment dropped twice as fast as previously expected in March. The jobless rate is at 7.1%, the lowest since German unification in 1990.
International ETF investors may hedge against the rising inflation through the SPDR DB International Government Inflation-Protected Bond ETF (NYSEArca: WIP), which tries to reflect the performance of the DB Global Government ex-US inflation-linked Bond Capped Index. The fund pays a distribution based on income plus the inflation adjustment, holds bonds from 18 foreign countries, has around a 30% weighting in emerging markets where inflation is rising earlier and faster, and has a 56% weighting in European countries.
In the U.S., TIPS are designed to hedge inflation by linking the principal to the Consumer Price Index (CPI). The main thing to keep in mind with TIPS is that the bond principal value will go up if the CPI increases, but you don’t have access to that increase until you receive your adjusted principal value at maturity.
U.S. TIPS options include:
- iShares Barclays TIPS (NYSEArca: TIP)
- iShares Barclays 0-5 Year TIPS (NYSEArca: TIPS)
- PIMCO 1-5 Year U.S. TIPS (NYSEArca: STPZ)
- PIMCO 15+ Year U.S. TIPS Index Fund (NYSEArca: LTPZ)
- PIMCO Broad U.S. TIPS Index Fund (NYSEArca: TIPZ)
- Schwab U.S. TIPS (NYSEArca: SCHP)
- SPDR Barclays Capital TIPS ETF (NYSEArca: IPE)
The difference between yields on 10-year notes and TIPS was at its widest point since March 9, signaling traders are positing for higher inflation, Bloomberg reported this week. [Treasury ETFs Soft As Traders Await Fed Speeches.]
For more information on international sovereign debt, visit our international Treasury bonds category.
For full disclosure, Tom Lydon’s clients own TIP.
Max Chen contributed to this article.