Despite the low crude oil prices, rising inflation expectations could keep pressure on Treasury bonds and related exchange traded funds.
Over the past month, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) fell 2.5%, Schwab Intermediate-Term U.S. Treasury ETF (NYSEArca: SCHR) dipped 1.4% and Vanguard Intermediate-Term Government Bond ETF (NYSEArca: VGIT) dropped 1.5%.
Meanwhile, the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) decreased 6.1%, PIMCO 25+ Year Zero Coupon US Treasury (NYSEArca: ZROZ) plummeted 10.1% andVanguard Extended Duration Treasury ETF (NYSEArca: EDV)
While some believed falling crude oil prices would help keep inflation depressed, cheaper energy costs could actually spur consumption and the rising demand for goods could fuel higher prices, Bloomberg reports.
“The economic data are pretty good. Inflation will increase, and the Fed will increase interest rates,” Kim Youngsung, head of overseas investment at South Korea’s Government Employees Pension Service, said in the article.
Crude oil futures plunged 53% in the past year, but snapped its seven-month decline in February, rising 3.2%. Additionally, U.S. economic data revealed that wage growth expanded the most in January since 2008, indicating inflation is set to accelerate.
Looking ahead, some argue that deflationary pressures are bottoming out and the outlook for inflation is on the rise. For instance, investors anticipate global prices to increase at an average 1.29% per year, compared to 0.99% in January, the lowest since 2010.
The Fed is also anticipating higher inflation rates as the “transitory effects” of lower oil prices diminish and the labor market improves.
Specifically, market observers are likely pointing to a demand-pull inflation, or when too much money chases too few goods. As unemployment falls, wages rise and consumers are left with more money to spend, demand may outstrip supply of goods. Since supply can’t meet the new demand over the short-term, prices tend to rise to meet the new equilibrium, resulting in inflation.
For fixed-income and bond ETF investors, rising inflation eats away at portfolio returns over time. Specifically, the so-called real, or inflation-adjusted, return is diminished as inflation rises. Consequently, investors are less apt to hold onto a fixed-income asset with diminished real returns, contributing to the fall in bond prices. [Rate-Sensitive ETFs Get Jammed Up]
For more information on the Treasuries market, visit our Treasury bonds category.
Max Chen contributed to this article.