The Fed Is Ready to Slow the Economy: Investing for Stagflation

The Federal Reserve minutes were released earlier this week, and they indicated that the central bank is ready to deliberately slow the economy through interest rate increases in order to tame inflation, reported the Wall Street Journal.

While the Commerce Department reported that personal consumption expenditures (PCE) increased by 6.3% year-over-year for the month of April, finally decelerating slightly but still near their 40-year high. The measurement of the PCE is the Fed’s preferred way of gauging inflation.

Spending for consumers increased by an adjusted 0.9% in April; at the same time, the savings rate declined to 4.4%, a drop from March’s revised 5%.

“We have finally reached the point where households are dipping into their $4 trillion of excess savings,” Stephen Stanley, chief economist at Amherst Pierpont, told the WSJ.

Meanwhile, disposable income was flat for the month when inflation-adjusted, a reflection of the inability of wage increases to keep pace with inflation. Spending grew on automobiles, and parts within goods and utilities, food services, and accommodations were the greatest gains in services spending.

“This is not a time for tremendously nuanced readings of inflation,” Federal Chair Jerome Powell said in an interview with the WSJ last week. “We need to see inflation coming down in a convincing way. Until we do, we’ll keep going.”

Investing for Stagflation With IVOL

As stagflation concerns grow for advisors and investors, in which inflation remains high while economic growth slows, many are looking to position their portfolios accordingly. The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) from KFAFunds, a KraneShares company, 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.

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 $1.6 billion in assets under management.

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