The Fed meeting in November was perhaps one of the most uneventful in recent times as hardly anyone expected any move this time. But even in this apparently boring meet, some comments were crucial (read: ETF Strategies to Implement Now).
Among very few changes made in Fed statements, adjustments in inflation expectations from the prior statements call for a look at TIPS ETFs that offer robust real returns during inflationary periods, unlike its unprotected peers in the fixed-income world.
What’s New in the Inflation Outlook?
The Fed has now indicated that“market-based measures of inflation compensation have moved up but remain low” instead of “market-based measures of inflation compensation remain low” said previously.
Plus, the Fed now expects inflation to pick up to 2% over the medium term. Earlier, it had expected inflation “to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term.”
Inside the Recent Uptick in Inflation
Consumer prices in the U.S. rose 1.5% year over year in September 2016 from 1.1% in August and matched market expectations. The reading came was the highest since October 2014. Higher rents were mainly responsible for this uptick.
Not only the U.S., the trend is improving in even more beleaguered regions like the Euro zone where inflation rate (0.4%) touched about a two-year high in September. Also, consumer prices for October in the Euro zone are expected to rise 0.5% year over year. British inflation (1%) also hit an about two-year high in September, following a 0.6% expansion in August and beating markets expectations of a 0.9% rise (read: How to Trade Strengthening Euro Zone Economy via ETFs).
Party Time for TIPS ETFs
These TIPS 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 recently made TIPS ETFs investors’ darlings as they are increasingly wagering on these inflation-protected bond ETFs. Market-based inflation expectations, mirroring yields on TIPS deducted from the yields on nominal government bonds, peaked in more than a year in late October, as per Wall Street Journal. Investors should note that TIPS raises the payout to buyers if inflationary reading surpasses certain marks.
iShares TIPS Bond ETF (TIP - Free Report) was one of the biggest beneficiaries of this trend, having hauled in $856.9 million in the last one month (as of November 1, 2016). In late October, there was a sell-off in global sovereign debt markets as investors added $1.1 billion into inflation-protected bond funds, as per an article published in Financial Times. The inflow in fact was “the second-largest since the start of 2007, according to EPFR, and the largest since April 2015.”
In a nutshell, with the U.S. economy and the job market on the mend, inflation will definitely increase in the coming months. Below we highlight a few outperforming TIPS ETFs which could be compelling investments at the current level (see: all TIPS ETFs here):
SPDR Barclays 1-10 Year TIPS ETF (TIPX - Free Report)
The $57.4-million fund follows the Bloomberg Barclays 1-10 Year Government Inflation-linked Bond Index and looks to track the performance of the inflation protected public obligations of the U.S. Treasury. The fund charges 15 bps in fees and holds about 25 securities. Average maturity of the fund is 5.51 years and modified adjusted duration is 4.39 years.
FlexShares iBoxx 5-Year Target Duration TIPS Index Fund (TDTF - Free Report)
The $652-million fund looks to give exposure to the price and yield performance of the iBoxx 5-Year Target Duration TIPS Index. The 14-security fund charges 20 bps in fees. The weighted average maturity is 5.43 years and modified adjusted duration is 5.21 years.
PIMCO Broad U.S. TIPS Index Exchange-Traded Fund (TIPZ - Free Report)
The $60.8-million fund tracks the BofA Merrill Lynch US Inflation-Linked Treasury Index. The fund charges 21 bps in fees. The 20-security fund has an effective maturity of 9.29 years and effective duration of 8.51 years.
TIP in Focus
The $20-5 billion fund holds 40 U.S. TIPS bonds having a weighted average maturity of 8.59 years and effective duration of 7.84 years. It charges 20 bps in fees.
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