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Time Is now to Prep for Higher Inflation

Tom Lydon
·3 mins read

This article was originally published on ETFTrends.com.

It's easy to get lulled into a false sense of security regarding benign inflation. However, the opportune time to prepare for rising prices is at the start of that trend, not after it's been present for some time. Enter the FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (NYSEArca: TDTT).

Over more than a decade of easy monetary policy, inflation was mostly absent, but there signs that's starting to change. In fact, there are inklings that TDTT is an ETF to consider over the near-term.

“Production costs are set to rise globally. Central banks are fundamentally changing their policy framework with the intent of running inflation above their targets. And the joint monetary-fiscal policy revolution – a necessary response to the Covid-19 shock – risks greater political constraints on the ability of central banks to lean against inflation,” according to BlackRock research.

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.

Talking 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. The Federal Reserve paints a compelling picture for those considering TDTT.

“This is an important shift in the central bank approach of recent decades when central banks only attempted to lift inflation back to target after extended undershoots. The Federal Reserve has adopted a new policy framework; it will deliberately push inflation above its 2% target to make up for past shortfalls. It also announced that tight labor markets will not need to be a consideration to manage inflation risks,” according to BlackRock.

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. TDTT has 20 holdings and a weighted average maturity of 3.92 years.

There are other reasons why investors ought to consider TDTT as an inflation-fighting tool of choice.

“Current breakeven inflation rates suggest this has not happened yet, opening a window of opportunity for long-term investors relative to our inflation expectations,” notes BlackRock. “For all of these reasons, we doubt nominal government bonds will provide the portfolio balance they historically have. We prefer inflation-linked bonds and alternatives for potential diversification and sources of resilience.”

For more on multi-asset strategies, please visit our Multi-Asset Channel.

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