TIPS ETFs Gain Momentum: Here's Why

TIPS ETFs are in good shape right now with15+ Year US TIPS Index ETF Pimco LTPZ, TIPS Bond iShares ETF (ASX:TIP) , Schwab US TIPS ETF (SIX:SCHP) , TIPS Barclays (LON:BARC) ETF SPDR SPIP, Barclays 1-10 Year TIPS SPDR (ASX:TIP) , iboxx 3Yr Target (NYSE:TGT) Dur TIPS ETF FlexShares TDTT, 0-5 Year TIPS Bond iShares ETF (ASX:TIP) and Short-Term Inflation Protected Vanguard (ASX:TIP) at one-month high.

Inside Rising Inflation Expectations

Consumer inflation in the United States firmed up in October thanks to rising healthcare and energy costs. The jump in inflation was the maximum in seven months. Healthcare costs spiked the most in more than three years and recreation recorded its biggest gain since early 1996.

If rent inflation were not subdued, the overall figure could have gained further. Annual consumer inflation rate in the United States increased to 1.8% in October of 2019 from 1.7% in September. Figures beat market expectations of 1.7%.

On a monthly basis, consumer prices rose 0.4%, above a flat reading in September and forecasts of 0.3%. Along with prices for medical care and for recreation, prices for used cars and trucks, for shelter, and for personal care gained in October, though the increase in the shelter index marked the smallest rise since October 2013, per tradingeconomics.

In any case, market expectations for inflation have increased lately thanks to Fed rate cuts, fading fears of a near-term recession and a soaring stock market. Several global economies have been cutting rates lately to boost inflationary outlook (read: Global Policy Easing Cycle Set in Motion: ETFs to Win).

“Based on the spread between the yields of 10-year U.S. government debt and Treasury inflation-protected securities of similar maturity, investors’ expectations for the average inflation rate over the next 10 years has risen to about 1.7 percentage points, compared to 1.55 percentage points at the end of last month,” per an article published on etfdb.

“The so-called 10-year break-even rate also witnessed its largest six-day gain since November 2016 earlier in the week. According to a recent Bank of America Merrill Lynch (NYSE:BAC) survey, nearly one-in-three fund managers anticipate that inflation will accelerate in the next 12 months, compared to a near zero expectation in recent months,” the article says.

Great Time for TIPS ETFs?

TIPS offers robust real returns during inflationary periods unlike its unprotected peers in the fixed-income world. These 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 increasing with rising consumer prices.

This mechanism has made TIPS ETFs investors’ darlings in recent times as they are increasingly wagering on inflation-protected bond funds. Though the expected trend of inflation depends a lot on the movement of energy prices, investors with a long-term view can count on the potential uptick in inflation as the U.S. economic backdrop appears more stable than before.

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