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U.S. Inflation Loses Steam in May: What About TIPS ETFs?

Zacks Equity Research

Bleak inflation has been a nagging concern for the developed economies. But the U.S. economy had set its way apart from that struggling bloc as its inflationary outlook seemed to be firming up (read: Quality ETFs in Focus as Global Growth Issues Spiral).

Against such a backdrop, on June 16, the economy came up with the May inflation reading that slowed from April and also came in below the consensus estimate. Consumer prices in May rose 1% year over year, falling slightly from a 1.1% rise in April. Sequentially, the consumer price index grew 0.2% in May, slowing from April's 0.4% rise and the analysts’ estimate of a 0.3% gain.

Behind the Headline Numbers

The data was backed by higher housing rent and healthcare costs but affected by a decline in food and transportation prices. On a year-over-year basis, food inflation slackened to 0.7% from 0.9% in April. Prices of transportation services rose 3.2% versus 3.3% in April while energy costs dropped 10% against an 8.9% plunge in April.

Among the drivers, rent rose 3.4% versus 3.2% in April on a year-over-year basis, medical care grew 3.5% compared with 3.1% in April and costs for services barring energy increased 3.2% from 3% noticed in April.

What Does Outlook Say?

Despite the deterrents, core inflation – excluding the food and energy –picked up pace to 2.2% from 2.1% in April. On a monthly basis, core inflation logged a 0.2% gain, the same as April. This indicates that the inflationary pressure is on the right direction barring some temporary glitches.

Moreover, in its recent meeting, the Fed also gave cues of firming inflationary outlook. Though the Fed cut the U.S. economic growth outlook and the projections for future funds rate, it indicated that inflation would pick up this year and raised its projected inflation rate to 1.4% from 1.2%. Moreover, with oil prices bucking its downing trend, the inflationary scenario should bump up.

Investors should also note that May saw the ‘third straight monthly rise in overall prices’ as oil prices recovered and the greenback lost steam. With this sort of economic backdrop likely to rule in the coming months, inflation outlook should shore up (read: Rising ETFs in a Falling Dollar Environment).

What Lies Ahead for TIPS ETFs?

The present scenario is not quite assuring for inflation-protected bonds, which offer robust real returns during inflationary periods. In fact, iShares TIPS Bond ETF TIP lost about 0.2% on June 16, though it gained slightly after hours.

Thus, investors with a long-term view can count on the potential uptick in inflation and invests in TIPS ETFs. With the economy taking root, inflation will definitely increase in the coming months.

Below we highlight a few TIPS ETFs which could be in focus ahead (see: all TIPS ETFs here):

PIMCO 15 Year US TIPS Index Fund (LTPZ)

This fund targets long-term securities of the TIPS market by tracking the BofA Merrill Lynch 15+ Year US Inflation-Linked Treasury Index. In total, the product holds 8 bonds having effective maturity of 26.65 years and carrying a high interest rate risk given the effective duration of 22.08 years. The ETF is less popular and less liquid with AUM of $102.9 million. LTPZ has generated excellent returns of about 11.1% so far this year (as of June 16, 2016).

PIMCO Broad US TIPS ETF TIPZ
 
This $86.8-million fund looks to track the BofA Merrill Lynch US inflation-linked treasury index. The fund holds 19 securities and has an effective maturity of 9.032 years while its effective duration is 8.52 years. The fund is up about 6% so far this year (as of June 16, 2016).

SPDR Barclays 1-10 Year TIPS ETF TIPX

This fund provides exposure to the TIPS market with effective maturity of 5.69 years. This is easily done by tracking the Barclays 1-10 Year Government Inflation-linked Bond Index. The ETF has amassed $23.8 million in its asset base and charges a low annual fee of 15 bps.
Holding 25 securities in its basket, the ETF zeroes in on the top-rated securities and has a moderate interest rate risk with effective duration of 5.56 years. The fund is up 3.6% so far this year (as of June 26, 2016).

 
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