ETF Trends
ETF Trends

After the Federal Reserve suggested that it is willing to see inflation rise before hiking interest rates, fixed-income investors turned to Treasury inflation protected securities and bond-related exchange traded funds to hedge against the negative effects of higher consumer prices.

In March, the iShares TIPS Bond ETF (NYSEArca: TIP) attracted $832.3 million in net inflows, according to ETF.com. Other TIPS-related ETFs, including the Schwab U.S. TIPS (NYSEArca: SCHP) and SPDR Barclays TIPS ETF (NYSEArca: IPE), also saw modest inflows.

Over the past week, TIP rose 1.4%, its strongest weekly rally since March 2015. Additionally, SCHP and IPE gained 1.3% in the past week.

Treasury bonds that hedge against higher inflation are attracting greater attention after a dovish U.S. Federal Reserve fanned the flames, reports Robin Wigglesworth for Financial Times.

“Just when it seemed like Tips had entered an abyss, they threw a surprise party,” Bank of America Merrill Lynch analysts wrote in a report.

The “break-even rates” – a gauge of expected inflation derived from cparing the yields of conventional Treasuries against TIPS – widened this month and increased in the wake of last week’s Fed meeting. The 10-year break-even rate rose to 1.62% last week, its highest since December, while the five-year rate rose to 1.52%, its highest since last summer.

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The widening break-even rates suggest that investors are anticipating increased inflation. Core US inflation has exceeded analyst estimates, climbing to an annual rate of 2.3% in February.

“The concern to me is inflation expectations,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC, told Bloomberg. “We’re are at a six-month high. Part of that is the rebound in oil.”

Richmond Fed President Jeffrey Lacker also projected consumer prices will accelerate as oil stabilizes.

“I am reasonably confident that, barring subsequent shocks, inflation will move back to the FOMC’s 2 percent objective over the medium term,” Lacker said at the Banque de France in Paris Monday.

The Fed also now expects just two quarter-point interest rate hikes for 2016, compared to its previous four planned rate moves. Consequently, money managers see the revisions as the Fed’s acceptance toward allowing inflation to accelerate above its 2% target.

“The signals are clear,” Chris Iggo, head of fixed income at Axa Investment Managers, said in a note. “The Fed is happy to allow core inflation to run higher before it really tightens because of the risk of a weaker international environment having some kind of stalling impact on the stronger US domestic economy.”

Consequently, with inflation expectations rising, ETF investors have turned to TIPS investment options. Treasury inflation-protected securities, or TIPS, are a type of Treasury security that is indexed to inflation as a way to shield investors from the negative effects of inflation. The securities’ par value rises with inflation as measured by the Consumer Price Index while interest rate remains fixed. TIPS also offer investors another layer of diversification as many aggregate bond funds exclude TIPS from their holdings.

iShares TIPS Bond ETF