TIPS are Hot: Is Inflation Back?
By Anthony Jerdine | Updated March 07, 2016

For the duration of the recovery, inflation has been sluggish, lagging the Federal Reserve’s target of 2%, even as improvements in the labor market would seem to indicate that the economy was healthy. As of Friday, however, there are indications that inflation is at last picking up. Treasury inflation-protected securities (TIPS) are attracting more attention from investors, indicating that the market expects inflation to pick up in the near future.

The 10-year breakeven inflation rate, which measures the spread between 10-year Treasury yields and 10-year TIPS, has reached 1.51 percentage points, rebounding after hitting a low of 1.18 on February 11. In other words, investors expect inflation to average slightly over 1.5% in the coming years.

While the level has not reached the ideal 2%, the uptick is an encouraging sign following a sharp drop in inflation expectations after Japan’s central bank introduced negative interest rates at the end of January. Combined with better-than-expected employment data released Friday morning, the increased interest in TIPS could prompt the Fed to consider hiking interest rates sooner than expected. Federal funds futures for November, which measure the betting market’s expectations for rate rises, rose to about even odds following the jobs report.

The iShares TIPS Bond ETF (TIP), the TIPS fund with the most assets under management, has seen a daily inflow of nearly $102 million as of Friday morning and $371 million over the past week, accounting for over 40% of its year-to-date gain of $914 million. The fund’s price has risen nearly 3% year-to-date, nearly erasing a 0.2% twelve-month decline.

The price index for personal consumption expenditures (PCE), the benchmark the Fed uses to track inflation, rose 1.3% year-over-year in January. The core index, which excludes food and fuel, rose 1.7%.

The Bottom Line
Worries about a deflationary environment have dogged markets for much of the recovery, and anxiety has only increased as an unprecedented negative interest rate policy spreads from Europe to Japan. Perhaps the fears are overblown, however, as markets’ inflation expectations appear to have bottomed out last month. As the rout in commodity and fuel prices drops out of comparisons, inflation data is likely to look more encouraging. That, in turn, could prompt action by the Federal Reserve.
TIPS are Hot: Is Inflation Back?


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