Avoid the TIPS rally. It's merely an inflation head-fake

Avoid the TIPS rally. It's merely an inflation head-fake
Recent performance can be deceiving.
MAY 24, 2016
Once upon a time, back when the Federal Reserve was still primarily dedicated to being an apolitical body strictly focused on monetary policy, there was a thing known as inflation, which was often preceded by the threat of inflation. Nowadays, seven years into a lackluster economic recovery that feels okay thanks to the Fed's ever-drifting mandate, we only have the threat of inflation, and only sometimes. That is an oversimplified explanation of what the economists and other big thinkers like to call the new normal, or the new neutral if you used to work at Pimco. Think of it as a time when interest rates are absurdly low, economic growth is barely visible, and inflation seems about as ominous as chapped lips. To the Fed's credit, it has done just about everything in its power to try and manufacture some semblance of inflation, including building up a record $5 trillion balance sheet through the experiment known as quantitative easing. For financial advisers and investors this kind of environment can create some interesting challenges, as well as some keen opportunities. But the key is caution. It's just a theory, but I'm guessing that the reality of quantitative easing is largely responsible for the periodic market reactions to the threat of inflation, whenever it rears its seductive head. The most recent example of which is right now. Witness the latest performance and inflows into Treasury Inflation Protected Securities, TIPS, a product specifically designed to take advantage of an inflationary environment. Over the six-week period through April, about $2.3 billion moved into TIPS, while the Barclays U.S. TIPS Index has seen a respectable 4.8% gain from the start of the year. Inflation-protection mutual funds over the same period gained 4.08%, according to Morningstar. That's a big swing for a category that fell by 2.36% last year. To the casual observer, this might look like a rallying cry for anything that will benefit in an inflationary environment. But it isn't that. Not even close. “You have to understand why this is happening, and it's not because investors' expectations have changed, it because the assets got to too cheap,” said Michael Arone, chief investment strategist at State Street Global Advisors. That's right, what might look to some like a defensive stampede into TIPS in anticipation of inflation, is mostly just an example of the bond market stepping in to bring things back into balance. And that imbalance was brought about, surprisingly enough, through fears related to deflation. As Mr. Arone details, when 2016 opened with renewed concerns of deflation and a possible U.S. recession, TIPS were pushed well below the so-called break-even rate where TIPS have no advantage over comparable Treasury bonds. That break-even rate, which fell below 1% toward the end of January, has since been pushed back up to the 1.6% range, reflecting more of a fair value for TIPS. In essence, the TIPS rally has been driven more by a tactical trade than an inflation threat. “Investors jumped in because they recognized that this is mispriced,” Mr. Arone said. “Inflation expectations had gotten too low, and now they're closer to right-sized.” He believes there might still be a few basis points worth of relative value left in the TIPS trade, but probably not enough to risk client assets trying to hedge non-existent inflation.

Latest News

Retirement delays, Social Security fears prompt advisors to rethink income strategies
Retirement delays, Social Security fears prompt advisors to rethink income strategies

Concerns about outliving savings and healthcare costs are reshaping how "Peak 65" Americans and advisors approach income planning.

Merrill Lynch on the hook for $3.7M after clients claimed sale of unsuitable private equity
Merrill Lynch on the hook for $3.7M after clients claimed sale of unsuitable private equity

Some investors recently have seen million dollar plus decisions by FINRA arbitration panels involving complex products decisions go their way.

Barred ex-Merrill Lynch advisor arrested in alleged $2.6M theft of former Miami Dolphin Pro Bowler
Barred ex-Merrill Lynch advisor arrested in alleged $2.6M theft of former Miami Dolphin Pro Bowler

Former advisor Isaiah Williams allegedly used the stolen funds from ex-Dolphins defensive safety Reshad Jones for numerous personal expenses, according to police and court records.

RIA moves: Modern Wealth tops $8.5B AUM as Aspen expands in Connecticut
RIA moves: Modern Wealth tops $8.5B AUM as Aspen expands in Connecticut

Modern Wealth's latest deal for a California-based fee-only RIA marks its fourth acquisition of 2025.

Empower defends private market access in 401(k)s in response to Warren scrutiny
Empower defends private market access in 401(k)s in response to Warren scrutiny

Sen. Warren has warned of private market investment risks due to opacity, illiquidity, and past regulatory issues.

SPONSORED How advisors can build for high-net-worth complexity

Orion's Tom Wilson on delivering coordinated, high-touch service in a world where returns alone no longer set you apart.

SPONSORED RILAs bring stability, growth during volatile markets

Barely a decade old, registered index-linked annuities have quickly surged in popularity, thanks to their unique blend of protection and growth potential—an appealing option for investors looking to chart a steadier course through today's choppy market waters, says Myles Lambert, Brighthouse Financial.