Prepare for the Return of Inflation With This ETF | ETF Trends

Statistically speaking, inflation remains benign, but with central banks around the world debasing currencies and the Federal Reserve likely to keep rates near zero for an extended period, the desired result of inflation may not be far off.

That could set the stage for investors to consider 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.

Recently, TIPS are getting some support from the Fed as they are among the myriad bonds the U.S. central bank is buying.

“Over the five weeks to April 15, the Fed purchased more than $1.2 trillion in Treasury securities across the curve, including $83 billion in TIPS. These massive purchases helped to clean up dealer balance sheets and restore market function,” said BlackRock in a recent note.

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.

“Recently, markets saw an extreme increase in the demand for liquidity, as precautionary cash-raising soared and risk aversion increased,” according to BlackRock. “This activity led to a sharp deterioration in market liquidity, causing liquidity discounts to expand substantially. As such, nominal yields fell dramatically relative to TIPS yields, resulting in a sharp contraction in break-even inflation rates and underperformance of the TIPS market.”

TDTT would be particularly useful in an environment where inflation data exceeds forecasts, meaning investors should monitor the breakeven inflation rate.

TDTT has a stablemate to consider, the FlexShares iBoxx 5Yr Target Duration TIPS ETF (NYSEArca: TDTF). The fund tracks the iBoxx 5-Year Target Duration TIPS Index.

“Given the quantity of monetary and fiscal support in the pipeline, we think real rates have room to move lower. TIPS provides targeted exposure to the expected real interest rates,” said BlackRock. “The Fed, so far, has been reluctant to embrace the use of negative nominal interest rates. Without negative rates, nominals have less price appreciation potential, but real rates still have substantial upside.”

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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.