Why now may be the time for TIPS

Matt Tucker explores the recently-resurfaced inflation conversation and discusses why now may be the time to revisit Treasury Inflation Protected Securities (TIPS).

I’m not sure if you noticed, but last month marked a bit of a milestone: The Labor Department noted that its Consumer Price Index, excluding food and energy, increased 0.3 percent in January, after a 0.2 percent gain in December. That doesn’t sound like much, but consider the context: It’s the most we’ve seen since August 2011. Indeed, inflation has been stubbornly low in recent years, but the Fed has continued to hint that inflation is just around the corner, and the market has been eagerly anticipating it.

Why it’s Time to Take Notice of Inflation (Really)

I talked about this a bit last year, at a time when inflation was muted, and breakevens, or market expectations for inflation, were turning up. I explained how break-even inflation and CPI indicators compared 2014-2015, and this is what we saw:

chart1-look-back

Now let’s take a look at it almost a year later:

chart2-horizon

 

We can see that headline inflation has broken out of its near 0 percent level and is up to 1.4 percent annualized. If we look at CPI ex food and energy, we see a similar pattern: recent increases have pushed inflation up to 2.2 percent. And while it may seem like the little boy who cried wolf — the story gets a little mixed when inflation expectations crashed mid-2015 — we can see that expectations have recently resurfaced, climbing back towards the 1 percent level.

Shifting the Inflation Conversation to TIPS

OK so we know that both realized inflation and inflation expectations have increased. For investors who are looking to protect their portfolio from further inflation increases, my colleagues and I agree: Treasury Inflation Protected Securities can be a good choice. TIPS are bonds issued by the U.S. Treasury whose payments increase when inflation increases. If inflation rises, so does the bond’s dollar coupon payment, and the amount you receive at maturity does, too.

If you’re interested in TIPS, but want to have more broad exposure, you may want to consider the iShares TIPS Bond ETF (TIP). It includes bonds with maturities of greater than one year.

 

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to the The Blog.

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