In anticipation of rising inflationary pressures ahead, fixed-income investors have turned to a number of Treasury inflation protected securities and bond-related exchange traded funds.
U.S. core inflation, which excludes more volatile oil and food prices, increased 0.1% in March, according to Reuters. Core CPI also ran 2.2% in March year-over-year after gaining 2.3% in February.
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.
Additionally, changes in inflation expectations can cause increased trading activity as investors adjust to a new break-even rate – the yield difference between nominal Treasury bonds and TIPS of the same maturity, and cause swings in TIP prices.
The 10-year breakeven inflation rate was hovering around 1.62% on May 10, well below its long-term average of about 2.15%, which suggests that TIPS are still cheap relative to nominal bonds – once the breakeven rate is above the historic average, TIPS would be seen as pricey.
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.
Potential investors should also be aware that TIPS are generally more volatile than traditional nominal Treasuries due to the inflation adjustments to their principal value.
Investors interested in TIPs exposure have a number of ETF options available.
- iShares TIPS Bond ETF (TIP)
- Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
- FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT)
- Schwab U.S. TIPS (SCHP)
- PIMCO 1-5 Year U.S. TIPS ETF (STPZ)
- SPDR Barclays TIPS ETF (IPE)
- iShares 0-5 Year TIPS Bond ETF (STIP)
- FlexShares iBoxx 5-Year Target Duration TIPS Index Fund Profile (TDTF)
- PIMCO 15 Year US TIPS Index Exchange-Traded Fund (LTPZ)
- PIMCO Broad U.S. TIPS Index Exchange-Traded Fund (TIPZ)
- SPDR Barclays 1-10 Year TIPS ETF (TIPX)
- SPDR Barclays 0-5 Year TIPS ETF (SIPE)
- SPDR DB International Government Inflation-Protected Bond ETF (WIP)
- PIMCO Global Advantage Inflation-Linked Bond Exchange-Traded Fund (ILB)
- iShares International Inflation-Linked Bond Fund (ITIP)
- iShares Global Inflation-Linked Bond Fund (GTIP)
- ProShares UltraShort TIPS (TPS)