US PCE Inflation Still Weak: Avoid TIPS ETFs

A key inflation measure, the Personal Consumption Expenditures (PCE) index, remained unchanged year over year in July, per data released on August 31, 2017. It increased 0.1% in July on a monthly basis.

Excluding food prices and fuel, core PCE measure — the Fed’s preferred measure of inflation — increased 1.4% in July year over year compared with 1.5% in June. However, it edged up 0.1% in July on a monthly basis. Therefore, it is still far from the Fed’s target of 2%.

Consumer Confidence

Although 236,000 people applied for jobless benefits in the week ended August 26, 2017 compared with 235,000 in the previous week, the labor market gives a healthy picture. New claims have been under 300,000 for 130 straight weeks.

Consumer spending increased 0.3% in July compared with 0.2% in June, per the Commerce department. This was primarily due to a 0.5% rise in wages. However, it was below analysts’ expectations of a 0.4% increase.

Moreover, consumer confidence in the United States increased to 122.9 from 120 in July, and above market estimates of 120.7. Also, a gauge of consumer expectations increased to 104 from 103 (read: U.S. Q2 GDP Revised Upward: ETFs in Focus).

Federal Reserve

Although the Fed had signaled another rate hike this year, economists expect it to hold off more rate hikes until the inflation reading reflects some strength. The Fed will meet again in September and economists expect it to come up with a detailed plan in order to start curtailing its $4.5 trillion balance sheet (read: What's in Store for the U.S. Treasury Bond ETFs?).

FOMC data shows that there is a 36.2% chance of a 25 basis point rate hike in December.

Let us now discuss a few inflation-protected ETFs (see all Inflation-Protected Bond ETFs here).

iShares TIPS Bond ETF (BK:TIP)

This fund focuses on providing exposure to TIPS, U.S. government bonds that adjusts its principal based on inflation numbers. It thus protects investors from unexpected increases in inflation.

It has AUM of $23.52 billion and charges a fee of 20 basis points a year. The fund has a weighted average maturity of 8.44 years, while it has an effective duration of 7.76 years. It has a dividend yield of 2.25%. TIP has returned 1.18% year to date, but has lost 0.95% in the last one year (as of August 31, 2017).

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 $21.3 billion and is a relatively cheaper bet as it charges a fee of 7 basis points a year. The fund has an average effective maturity of 2.8 years and an average duration of 2.8 years as well. It has a dividend yield of 0.76%. VTIP has returned 0.69% year to date and 0.45% in the last one year (as of August 31, 2017).

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 (TIPS) Index.

It has AUM of $2.44 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 8.5 years and an effective duration of 7.8 years. It has a dividend yield of 1.96%. SCHP has returned 1.33% year to date, but has lost 1.71% in the last one year (as of August 31, 2017).

FlexShares iBoxx 3-Year Target Duration TIPS Index Fund TDTT

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

It has AUM of $2.08 billion and charges a fee of 20 basis points a year. The fund has a weighted average maturity of 3.04 years and a modified adjusted duration of 3.04 years as well. It has a dividend yield of 1.54%. TDTT lost 0.36% year to date and 0.04% in the last one year (as of August 31, 2017).

Bottom Line

Inflation numbers have been consistently weak, raising concerns in the markets. Therefore, the outlook for further rate hikes and the inflation figure reaching Fed’s 2% target has been clouded. As a result, given the current market environment, we believe it is best to avoid inflation-protected securities for now.

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