Is Stagflation Happening Now? | ETF Trends

The consumer price index for April came in at 8.3%, and while it is slightly lower than March’s 8.5%, it was still higher than expected. More telling was the core CPI reporting, a measurement of inflation minus energy and food, which came in at 6.2%. That figure is above expectations and a big signal that inflation hasn’t peaked yet.

The core CPI represented a 0.6% gain month-over-month and meant that real wages, when inflation-adjusted,  decreased 0.1% for hourly workers as the 0.3% average hourly earnings gain continues to lag inflation, reports CNBC. Average hourly earnings in the past year have made progress, gaining 5.5%, but inflation has stripped away those gains consistently, leaving the real earnings average at a loss of 2.6% over the last year.

Q&A: Nancy Davis on the Fed, Inflation & Opportunities in Today's Market“Wednesday’s CPI data once again surprised to the upside and the market now expects the Federal Reserve to hike interest rates by another 190 basis points by the end of 2022,” Nancy Davis, founder of Quadratic Capital Management, said in a communication to ETF Trends. “Investors need to keep in mind that the Federal Reserve’s aggressive forward guidance has already moved the interest rates markets and it is failing to control realized inflation.”

With the Fed signaling a 0.50% interest rate increase in both June and July as Federal Reserve Chair Jerome Powell has indicated a desire to frontload rate hikes and begin Fed balance sheet reductions in June, markets have been falling on investor fears since last Thursday.

Davis believes that the rate increases will not have an impact on some of the inflationary pressures at play, such as supply chain issues, and that the hikes alone don’t provide solutions for increasing commodity prices, a tight labor market, and more.

“The combination of elevated inflation and Federal Reserve rate hikes increases the risk of stagflation, which is an awful environment for investors that typically results in stocks and bonds losing value simultaneously,” said Davis. “We may already be in a stagflationary environment, as stocks and bonds have declined in value together so far this year, inflation remains elevated, and the economy contracted in the first quarter.”

Investing for Stagflation With IVOL

The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) from KFAFunds, a KraneShares company, is managed by Nancy Davis and is designed to have a twofold hedge against an increase in fixed income volatility and/or an increase in inflation. The fund also seeks to maximize yield curve increases, either brought about by long-term interest rates increasing or short-term interest rates falling; both are tied to big equity market declines.

“We should not assume that the Federal Reserve will be able to control inflation. Inflation linked assets can offer diversification and could be helpful in a portfolio in case inflation doesn’t go down as quickly as most expect,” explains Davis.

IVOL is the first of its kind in active and passive options and offers access to the OTC fixed income options market, the mechanism it uses for long interest rate volatility. The fund invests in a mix of U.S. Treasury Inflation-Protected Securities (TIPS) of any maturity, which are U.S. government bonds whose principal amounts increase with inflation.

IVOL also invests in long options directly tied to the shape of the U.S. interest rate swap curve, which steepens when the spread between longer-term debt instrument swap rates and shorter-term debt instruments grows larger, flattens when the spread grows smaller, and inverts when the spread is negative.

IVOL is actively managed by Quadratic Capital Management, an alternative asset management firm with experience in the options and volatility markets. It expects to invest less than 20% of the fund in option premiums and seeks to purchase options with a time-to-expiration between six months and two years.

IVOL carries an expense ratio of 1.05% and has almost $1.65 billion in assets under management.

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