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

The 2025 InvestmentNews Awards Excellence Awardees revealed
The 2025 InvestmentNews Awards Excellence Awardees revealed

From outstanding individuals to innovative organizations, find out who made the final shortlist for top honors at the IN awards, now in its second year.

Top RIA Cresset warns of 'inevitable' recession amid tariff uncertainty
Top RIA Cresset warns of 'inevitable' recession amid tariff uncertainty

Cresset's Susie Cranston is expecting an economic recession, but says her $65 billion RIA sees "great opportunity" to keep investing in a down market.

Edward Jones joins the crowd to sell more alternative investments
Edward Jones joins the crowd to sell more alternative investments

“There’s a big pull to alternative investments right now because of volatility of the stock market,” Kevin Gannon, CEO of Robert A. Stanger & Co., said.

Record RIA M&A activity marks strong start to 2025
Record RIA M&A activity marks strong start to 2025

Sellers shift focus: It's not about succession anymore.

IB+ Data Hub offers strategic edge for U.S. wealth advisors and RIAs advising business clients
IB+ Data Hub offers strategic edge for U.S. wealth advisors and RIAs advising business clients

Platform being adopted by independent-minded advisors who see insurance as a core pillar of their business.

SPONSORED Compliance in real time: Technology's expanding role in RIA oversight

RIAs face rising regulatory pressure in 2025. Forward-looking firms are responding with embedded technology, not more paperwork.

SPONSORED Advisory firms confront crossroads amid historic wealth transfer

As inheritances are set to reshape client portfolios and next-gen heirs demand digital-first experiences, firms are retooling their wealth tech stacks and succession models in real time.