- Treasury inflation protection securities (TIPS) and the corresponding ETFs have not garnered as much attention
- That could change as now could be the ideal time for advisors and investors to consider adding inflation hedges to their portfolios
- If the Fed raises rates too quickly, it could raise deflationary pressures, which could send the economy into a spiraling decline as cash becomes more valuable
Without much inflation in recent years, Treasury inflation protection securities (TIPS) and the corresponding exchange traded funds have not garnered as much attention as other corners of the fixed income universe.
That could be starting to change as now could be the ideal time for advisors and investors to consider adding inflation hedges to their portfolios.
If the yield curve steepens, every fixed-income asset will see higher rates but longer dated bonds will see yields rise the most, suggesting that the economy is quickly heating up. That would make ETFs like TIP more attractive to fixed income investors.
Last year’s sudden plunge in oil prices has helped keep prices low, but the Fed believes the drop in oil prices will only be short-term. However, the stronger dollar is a dominant factor in keeping commodity prices depressed. The iShares TIPS Bond ETF (NYSEArca: TIP) is a popular avenue for investors looking for TIPS exposure.
“It might seem strange to worry about inflation with oil prices plummeting. But it’s precisely when no one cares about a risk that it becomes cheapest to hedge. Typically, TIPS are compared with traditional Treasury bonds. The narrower the yield spread between the two, the cheaper TIPS are on a relative basis. Currently, the spread is 1.51 percentage points for 10-year TIPS versus 10-year Treasuries,” reports Lewis Braham for Barron’s.
If the Fed raises rates too quickly, it could raise deflationary pressures, which could send the economy into a spiraling decline as cash becomes more valuable, prices continue to fall and Americans withhold spending to buy something cheaper tomorrow. [ETFs for a Deflationary Period]
The Fed is targeting an inflation rate of about 2%. Additionally, looking at the Fed’s preferred inflation gauge, the Commerce Department’s consumption expenditure price index, inflation has undershot 2% for over two-and-a-half years.
There are some issues with TIPS investors need to be aware of.
“The inflation adjustment, which perfectly mirrors the CPI, increases the principal that will be returned to investors. Yet the fixed-income component can actually nullify that hedge. That’s because the longer the duration of any bond, the more sensitive it is to increases in interest rates. And rates generally rise with inflation. So the price of a TIPS can fall while its inflation component gains,” according to Barron’s.
iShares TIPS Bond ETF
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.