US fund managers seek to safeguard portfolios against inflation

Line chart of Year-to-date cumulative flows into TIPs funds ($bn) showing Investors return to inflation-linked bonds

Demand for inflation-protected bonds has intensified in the US, as investors look to shield portfolios against the risk of a spike in consumer prices as economic activity rebounds from the coronavirus crisis.

The mounting appetite for Treasury inflation-protected securities — US government bonds whose returns are adjusted in line with movements in consumer prices — has sent their yields close to record lows in some cases.

The yield on 30-year Tips currently hovers just above an all-time trough of minus 0.26 per cent, according to Tradeweb data. Five- and 10-year Tips yields have also dropped, closing near levels last seen in 2013 and 2012, respectively.

More than $5bn flowed into funds investing in Tips over the four weeks ending July 8, according to data from EPFR. That marked a reversal from outflows seen during March and April, the figures show.

Growing appetite for these securities comes even as the most recent data showed that core PCE, the US Federal Reserve’s favourite inflation gauge, dropped to 1 per cent on a year-over-year basis, down from 1.7 per cent at the start of the year and well below the Fed’s 2 per cent target.

Market measures of inflation expectations have remained subdued too. A swap rate that measures estimates of the average level of US inflation over five years, starting five years from now, is at 1.8 per cent. 

While few investors fear an immediate resurgence in inflation, what has become the “concern du jour”, according to Steven Blitz, chief US economist at TS Lombard, is what happens when a recovery takes hold. Unprecedented stimulus measures from the central bank, combined with a huge increase in government spending aimed at shoring up demand, could push up prices, eroding the real value of already-low returns on bonds.

“I do not expect inflation for the next 12-18 months,” he said. “After that, I could see the economy having a higher inflation bias.”

Line chart of US 10-year break-even rate, % showing Inflation expectations point to downbeat outlook

Officials at the Fed appear to be relaxed about the prospect of overshooting the 2 per cent inflation target, at least temporarily.

On Wednesday, Philadelphia Fed president Patrick Harker echoed comments made by Fed governor Lael Brainard a day earlier advocating for the central bank to let inflation overshoot its target.

“I am supportive of the idea of letting inflation get above 2 per cent before we take any action with respect to the fed funds rate,” Mr Harker said in an interview with Bloomberg Television.

James Athey, a bond portfolio manager at Aberdeen Standard Investments, said such comments should be seen as evidence that the Fed “won’t be proactive about withdrawing stimulus”.

Even investors who are deeply sceptical about the prospects of runaway consumer prices acknowledge the benefits of seeking out protection against such risks.

“It is always wise for investors to be mindful of risks that may not be a likely scenario,” said Brett Wander, chief investment officer of fixed income at Charles Schwab. “Having some inflation-protected securities in your portfolio makes sense, even if inflation is an unlikely scenario.”