Too Much Optimism Warrants a Look at This Bond ETF

An overabundance of optimism surrounding the U.S. Federal Reserve’s rate pause could be creating hubris among bond investors. That said, it could be necessary to brace for more rate hikes with the Vanguard Short-Term Inflation-Protected Securities Index Fund ETF Shares (VTIP).

In other parts of the globe, inflation is already proving to be persistent. Whether or not this has a spillover effect into the U.S. remains to be seen, but bond investors shouldn’t be too optimistic that rate hikes are a relic of the past.

Per a Financial Times report, “the Bank of England lifted its rate by a more than expected 0.5 percentage points to 5 per cent, a day after official data pointed to UK inflation remaining higher than forecast.” This move by the Bank of England isn’t an isolated issue.

Additionally, other European countries are also continuing to raise rates in order to stave off sticky inflation. Per the same report, the “Swiss National Bank raised its main policy rate 0.25 percentage points to 1.75 per cent, and did not rule out additional increases” and “Norway’s central bank lifted its key rate from 3.25 per cent to 3.75 per cent and said it could raise it again in August.”

So while the U.S. Federal Reserve just paused on rate hikes, the notion that bond prices should drift higher through the rest of the year warrants its own pause. The threat of rate hikes still exists regardless of whether it comes at a more hawkish or dovish tone from the Fed, given the recent moves from other central banks.

“We are seeing a slew of central bank decisions today that send the message that inflation continues to be a threat, and [they] are continuing to take that very seriously,” said Joel Kruger, market strategist at LMAX Group.

A Short-Term Option for the Current Environment

VTIP seeks to track the Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index performance. The index is a market-capitalization-weighted index that includes all inflation-protected public obligations issued by the U.S. Treasury with remaining maturities of less than five years.

The shorter duration allows investors to mitigate rate risk while also getting exposure to TIPS in the event of more rate hikes if inflation proves to be more persistent than initially anticipated. On its product website, Vanguard noted that shorter-duration TIPS exposure can help minimize the volatility inherent in a TIPS fund with holdings that have a longer duration.

For more news, information, and analysis, visit the Fixed Income Channel.