Oil Could Seal the Fate of TIPS Investors in the Short Term

With oil prices seemingly in the gutter, a bounce is likely expected, but for now, the commodity is causing inflationary expectations to take a back seat. However, when oil prices do recover, particularly in the short term, this presents an opportunity for Treasury inflation-protected securities (TIPS).

At the present time, inflationary expectations haven’t been this low since the financial crisis over a decade ago.

“With market-based inflation expectations now at such beaten-up levels, and with the disinflationary effect of falling energy prices set to fade, we see an opportunity to play for a cyclical rebound in inflation breakevens across the developed markets,” said analysts at BCA Research, in a Tuesday note, per a MarketWatch report.

Per the report, “BCA analysts expect Brent crude oil, the global benchmark, to rise to $42 a barrel by the end of this year, and $78 by the end of 2021.” Furthermore, the report noted that recovering oil prices “could thus have a knock-on impact for consumer price inflation, especially as the muted inflation backdrop even before the COVID-19 pandemic led swings in energy prices to become ‘the marginal driver of both realized and expected inflation,’ said the BCA analysts.”

Oil Could Seal the Fate of TIPS Investors in the Short Term

If a short term rise in oil prices does feed into inflationary pressures, exchange-traded fund (ETF) investors can utilize funds like the IQ Real Return ETF (NYSEArca: CPI) as an option to hedge against inflation. CPI seeks investment results that correspond to the IQ Real Return Index–a “fund of funds” that invests its net assets in the investments incorporated within the underlying index.

Fixed-income investors using corporate bond ETFs are subject to duration risk tied to interest rates, but in an economic environment where inflation is also rising, an ETF like CPI would be of benefit. Building off that point, another ETF to consider is the Goldman Sachs Access Inflation Protected USD Bond ETF (GTIP).

GTIP seeks to provide investment results that closely correspond to the performance of the FTSE Goldman Sachs Treasury Inflation Protected USD Bond Index. The index is designed to track the performance of inflation-protected, fixed rate U.S. Treasury Securities denominated in U.S. dollars (“USD”) that meet certain screening criteria.

Lastly, another fund to consider is the Vanguard Short-Term Inflation-Protected Securities Index Fund ETF Shares (VTIP). This ETF seeks to track the performance of the Bloomberg Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index.

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 5 years. The manager attempts to replicate the target index by investing all, or substantially all, of its assets in the securities that make up the index, holding each security in approximately the same proportion as its weighting in the index.

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