Do ETF Investors Need Inflation Protection Now?

U.S. markets recently saw a selloff on apprehensions of rising rates. The S&P 500 entered correction territory, as it declined more than 10% from the record high set in January. Strong wage growth and jobs data in January induced fears of inflation making a comeback and led investors to bet on aggressive rate hikes.

However, investors’ worst fears dissipated as U.S. inflation remained subdued in February, just a day after weak wage growth numbers were reported. Although the U.S. economy reported strong job gains, it was not enough to keep driving Treasury yields higher. Equities reacted positively to the inflation numbers from last month compared with steep declines following the inflation readings for January (read: 3 ETFs to Benefit as Faster Rate Hike Worries Cool Down).

Into the Headlines

The U.S. economy added 313,000 jobs in February — the highest since July 2016 — compared with a Reuters forecast of 200,000. However, tepid wage growth reduced fears of the Fed going on a rate hike spree. Average hourly earnings in the United States grew a mere 0.1% in February compared with 0.3% in the previous month (read: 6 Sector ETFs to Win on Strong February Job Data).

Moving on to inflation, consumer prices increased 2.2% year over year in February, up from 2.1% reported in the previous month. Moreover, core inflation, which excludes prices of volatile items such as food and oil, increased 1.8% in February, unchanged from January.

"While there is evidence of building inflationary pressures in certain components, the annual growth rates (especially for the core CPI) do not suggest a breakout in inflation yet," per a CNC article citing Ben Ayers, senior economist at Nationwide.

As a result, muted inflation numbers led to a decline in the greenback and in the expectations of aggressive rate hikes by the Fed. This report was the last before Fed officials meet to decide on monetary policy next week, where they are widely expected to go ahead with a rate hike. Per the CME FedWatch tool, there is an 88.8% chance of a 25-basis point rate hike in the March FOMC meet.

What’s in Store for TIPS?

With a rate hike almost certain in March, it is still too early to comment whether or not four hikes are possible this year. Moreover, President Trump’s plan to impose tariffs on steel and aluminum may spark off a trade war, with other countries announcing retaliatory measures. This may exert cost pressure on the U.S. economy and lead to inflation making a comeback.

As a result, inflation-protected ETFs might still offer a safe haven to investors. However, we might see some portfolio reallocation as investors’ risk appetite increases on reduced interest rate fears and some assets saved for inflation protection are invested in higher risk investments.

iShares TIPS Bond ETF (BK:TIP)

This fund focuses on providing exposure to Treasury Inflation Protected Securities (TIPS), U.S. government bonds that adjusts its principal based on inflation numbers. It thus protects investors from an unexpected spike in inflation.

It has AUM of $24.8 billion and charges a fee of 20 basis points a year. The fund has a weighted average maturity of 8.15 years and an effective duration of 7.48 years. TIP lost 1.7% year to date but has returned 1.6% in a year.

Vanguard Short-Term Inflation-Protected Securities ETF (BK:TIP)

This ETF focuses on providing exposure to short-term TIPS, whose face value is indexed to inflation.

It has AUM of $4.8 billion and is a relatively cheaper bet as it charges a fee of 6 basis points a year. The fund has a weighted average maturity of 2.7 years and an effective duration of 2.7 years as well. VTIP has lost 0.2% year to date but has returned 0.7% in a year.

Schwab U.S. TIPS ETF (SIX:SCHP)

This fund seeks to invest in TIPS and track the performance of Bloomberg Barclays (LON:BARC) U.S. Treasury Inflation Protected Securities Index.

It has AUM of $3.2 billion and is a cheaper bet as it charges a fee of 5 basis points a year. The fund has a weighted average maturity of 8.3 years and an effective duration of 7.6 years. SCHP has lost 1.7% year to date but has returned 1.6% in a year.

FlexShares iBoxx 3-Year Target Duration TIPS Index Fund TDTT

This fund seeks to invest in inflation-protected securities and tracks the performance of the iBoxx 3-Year Target Duration TIPS Index.

It has AUM of $2.1 billion and charges a fee of 18 basis points a year. The fund has a weighted average maturity of 3.73 years and a modified adjusted duration of 3.08 years. TDTT has lost 0.2% year to date but has returned 0.1% in a year.

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