While some corners of the fixed income market have languished in the wake of last week’s stunning presidential election results, one area is standing out: Treasury inflation protected securities (TIPS).
This year, investors have been pouring into ETFs such as the iShares TIPS Bond ETF (NYSEArca: TIP) and the Schwab U.S. TIPS (NYSEArca: SCHP). That trend looks poised to continue as TIPS have been favored destination after Donald Trump’s upset victory in last week’s election. Additionally, data confirm U.S. inflation is creeping higher.
Investors will typically look at TIPS ahead of an inflationary period since buying TIPS after inflation has gone up means that the security has already priced in the inflation and investors would likely be overpaying for the TIPS exposure.
Potential investors should also be aware that TIPS are generally more volatile than traditional nominal Treasuries due to the inflation adjustments to their principal value.
“The yield on the 10-year Treasury note has moved from 1.86% as of Tuesday’s close to 2.08%. That’s a 22 basis point move. If look you look at the 10-year inflation- linked security, over same period the yield has gone up about 5 basis points. You have a slight negative return, but much less than Treasuries,” according to a Standish Mellon note posted by Amey Stone of Barron’s.
TIPS ETFs are 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.[related_stories]
However, rising inflation expectations have weighed on the bond market, with yields on benchmark 10-year Treasuries back up to 2.12%. Observers believe rising inflation would weigh on real yields, which diminishes the attractiveness of debt assets.
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.
Standish Mellon “expects TIPS to continue to hold up a lot better than Treasuries as Trump administration policies like lower taxes, more infrastructure spending and less regulation are expected to lead to more inflation,” according to Barron’s.
For more information on the fixed-income market, visit our bond ETFs category.
iShares TIPS Bond ETF (NYSEArca: TIP)
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.