While many market observers maintain that inflation is benign, the debate is heating up in a big way, potentially calling more attention to ETFs such as the FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (NYSEArca: TDTT).
Treasury Inflation-Protected Securities (TIPS) are popular among fixed-income investors looking to protect against the scourge of inflation and ETFs make it easier to access TIPS.
“Whether the Federal Reserve’s policies and massive U.S. debt are the kindling for an inflationary fire has yet to be seen, but the very idea the U.S. could face a spiral of rising prices is a topic dividing Wall Street,” reports Patti Domm for CNBC. “Some big investors believe spiking inflation could become a problem. Billionaire hedge fund manager Stanley Druckenmiller, for one, says the Fed’s actions and congressional spending could take inflation to 5% to 10% in the next four to five years.”
TDTT would be particularly useful in an environment where inflation data exceeds forecasts, meaning investors should monitor the breakeven inflation rate.
Time for TDTT
While inflation expectations may remain muted now, investors are already looking into TIPS as a hedge against rising prices ahead. TIPS returns are affected by interest-rate risk as well as changes in the principal value when the Consumer Price Index moves. TIPS will adjust their principal value upward in response to a higher CPI, but the reverse occurs during periods of deflation.
“Since the financial crisis more than a decade ago, inflation has rarely hit the Fed’s 2% target. This week, the Fed is meeting, and Fed Chairman Jerome Powell is expected to discuss its new policy of an average inflation target at his Wednesday afternoon press briefing. The Fed’s new policy means it would allow inflation to rise above the target, without moving immediately to tighten policy — or raise interest rates from its current level of zero,” according to CNBC.
However, all the asset buying and easy money policies pushed forth by the Fed could spark inflation at much more rapid rates than previously expected.
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.
Investors now argue that the Federal Reserve’s rate cuts this year have bolstered the outlook on inflation, with some even contending that inflation may rise fast enough to force the Fed to hike rates.
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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.