In anticipation of rising inflationary pressures ahead, fixed-income investors have turned to a number of Treasury inflation protected securities and bond-related exchange traded funds.
U.S. core inflation, which excludes more volatile oil and food prices, increased 0.1% in March, according to Reuters. Core CPI also ran 2.2% in March year-over-year after gaining 2.3% in February.
While inflation expectations may remain muted now, investors are already looking into TIPS as a hedge against rising prices ahead. TIPS returns are affected by interest-rate risk as well as changes in the principal value when the Consumer Price Index moves. TIPS will adjust their principal value upward in response to a higher CPI, but the reverse occurs during periods of deflation.
Additionally, changes in inflation expectations can cause increased trading activity as investors adjust to a new break-even rate – the yield difference between nominal Treasury bonds and TIPS of the same maturity, and cause swings in TIP prices.
The 10-year breakeven inflation rate was hovering around 1.62% on May 10, well below its long-term average of about 2.15%, which suggests that TIPS are still cheap relative to nominal bonds – once the breakeven rate is above the historic average, TIPS would be seen as pricey.