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Will 2017 Be a Year of Global Reflation & TIPS ETFs?

Sanghamitra Saha

Global consumer inflation is on an uptrend lately though it is still far from the goal. This specifically holds true for the U.S. as the inflationary outlook recently got a boost on Donald Trump’s win. Trump's proposed $1 trillion spending plan and slash in personal and corporate taxes injected fresh optimism into the otherwise decent U.S. inflation (read: 5 Top-Ranked Sector ETFs Thankful to Trump).

The U.S. economy has been enjoying an easy money policy by the Federal Reserve for long. The Fed enacted a liftoff last December after almost a decade and intends to speed up tightening as and when economic indicators become favorable. Since the last rise in the PCE price index was 1.4% (in October) – short of the Fed’s goal of 2% -- the rates are still lurking at lower levels.

The scenario is the same across the pond where the ECB is still pursuing a QE policy along with negative rates. Even Japan has been practicing the same ultra-easy monetary policy in an attempt to boost inflation. All these easy money policies should boost inflationary outlook further in the coming days.

If this was not enough, as per an article published on financial times, “Trump’s threat to impose tariffs on countries such as China and dismantle the free-trade zone covering the U.S., Mexico and Canada was likely to fan inflation (read: How Deep is Trump Trouble for Mexico ETFs?).”

Investors should also note that multi-year low oil prices for about two years have been one of the key reasons for subdued global inflation. Now, with OPEC deciding on a production cut from early next year for six months, a certain uptick in oil prices should be seen. This should translate into global inflation. 

All these efforts by global central banks, the OPEC move and the Trump effect seem to have paid off as expectations of a spurt in global inflation are now at the highest level in over 12 years. About 80% of the respondents in a survey conducted by Bank of America Merrill Lynch in mid-November see a rise in global price levels over the coming one year – the highest since June 2004, as per an article published on MarketWatch.

Fitch Ratings also expects a reflationary trend in 2017. The agency recently noted that the total outstanding negative-yielding sovereign debt dropped to $9.3 trillion as of November 28, from $11.7 trillion seen at the end of the first half of 2016. This is because if global inflation picks up, central banks will slowly shift from negative interest policies.

Inside Global Inflation

Consumer prices in the U.S. grew 1.6% year over year in October 2016, up from a 1.5% rise in September and in line with market expectations. This is the highest inflation rate since October 2014.

Consumer prices in the Euro zone are also hovering at a two-and-a-half year high. Japan also witnessed a 0.1% year-over-year rise in consumer prices in October, marking the first increase in eight months.

Consumer prices in Australia grew 1.3% through the year to Q3 from 1.0% in the prior three-month period and beat market expectation of a 1.1% rise. China saw prices rising 2.1% year over year in October, higher than the 1.9% rise in September and matching market expectations. It was the highest inflation rate since April.

Party Time for TIPS ETFs

TIPS offers robust real returns during inflationary periods, unlike its unprotected peers in the fixed-income world. These securities pay an interest on an inflated-principal amount (principal rises with inflation) and when the securities mature, investors get either the inflation-adjusted principal or the original principal, whichever is greater.

As a result, both principal amount and interest payments will keep on rising with increasing consumer prices. This mechanism has made TIPS ETFs investors’ darlings in recent times as they are increasingly wagering on inflation-protected bond ETFs.

Below we highlight a few TIPS ETFs that outperformed U.S. Treasury ETFiShares 20+ Year Treasury Bond TLT in the last 10 days (as of November 8, 2016) (read: Is the Treasury Bond ETF Rally About to End?).

PIMCO Global Advantage Inflation-Linked Bond Active ETF ILB)

The 276-security fund is heavy on the U.S. (34.88%) followed Japan (10.375), Eurozone (13.13%) and Europe non-EMU (10.62%). The 30-day SEC yield is 3.30% (as of November 8, 2016). Its effective duration and maturity are 8.70 years and 10.52 years, respectively, indicating moderate interest rate and default risks.

SPDR Citi International Government Inflation-Protected Bond ETF WIP

The 181-bond fund is most exposed to the UK (23.04%) followed by France (8.40%), Brazil (8.31%) and Italy (5.55%). The fund charges 50 bps in fees. Average maturity and adjusted duration of the fund are 13.84 years and 11.96 years, respectively.

FlexShares iBoxx 3-Year Target Duration TIPS Index Fund TDTT

The 12-holding fund targets a modified adjusted duration of 3.13 years and weighted average maturity of 2.80 years, representing low interest rate and default risks. The net expense ratio of the U.S.-based fund is 0.20% (read: Should You Buy These Bond ETFs Instead of Treasury?).

iShares 0-5 Year TIPS Bond ETF STIP

The 15-holding fund looks to track the short-term U.S. TIPS. The product has an effective duration and maturity of 2.47 years and 2.52 years, respectively.  Bonds with three-five years of maturity get half of the focus of the fund.

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ISHARS-20+YTB (TLT): ETF Research Reports
 
PIMCO-GA ILBETF (ILB): ETF Research Reports
 
SPDR-DB IG IPB (WIP): ETF Research Reports
 
FLEXS-IB 3Y TAR (TDTT): ETF Research Reports
 
ISHARS-0-5YTIPS (STIP): ETF Research Reports
 
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