Inflation-linked bond ETFs are back in play for investors after central banks signalled plans to freeze interest rates hikes for the foreseeable.
Last Wednesday, the Federal Reserve said it would stand by its previous commitment of not hiking interest rates until 2024. There was some division though at the Federal Open Market Committee (FOMC) meeting, however, with seven of the 18 members expecting a rate rise by 2023 while one hawk called for a hike as early as December.
While Fed chairman Jerome Powell expects inflation to hover just above the 2% target until the rate hike, this forecast excludes inflation expectations for 2021 which are predicted to comfortably exceed the 2% mark.
Likewise, Goldman Sachs said the Democrats are looking to pass a $4trn of stimulus later in the year, to be brought into effect over the coming decade, with campaign promises on infrastructure spending likely to be fulfilled in the nearer term.
This comes after US President Joe Biden signed his $1.9trn stimulus package to support the US economy in the wake of the coronavirus pandemic. The extent to which these measures have been factored into the Fed’s inflation outlook is unknown.
Against this reflationary backdrop – with the economy yet to fully reopen – some investors have begun shifting their allocations towards hedges such as the iShares $ TIPS UCITS ETF (ITPS) which has seen $270m inflows since the start of the year, according to data from ETFLogic.
Bank of England follows suit
Taking a tip out of the Fed’s playbook, the Bank of England (BoE) ditched the long-odds option of negative interest rates and kept rates at 0.1%.
The BoE’s Monetary Policy Committee (MPC) voted unanimously in favour of the freeze alongside preserving its asset purchase target of £895bn.
In post-meeting remarks, the BoE governor Andrew Bailey offered a dose of added optimism, stating the UK economy shrank at a lower rate than anticipated in January, and that given the ‘marked’ decrease in COVID-19 hospitalisations, restrictions could be lifted sooner than was advertised in February.
This cheerful messaging from the UK’s central bank, as well as further support from the government – including an extension of the stamp duty relief scheme – are both conducive to the pro inflation narrative.
Responding to this, interest in the Lyxor Core UK Government Inflation-Linked Bond UCITS ETF (GILI) has piqued in trailing weeks with inflows during the year-to-date coming to $16.8m, according to ETFLogic.
Time for protection?
The recent decisions from two major developed market central banks should create an environment where inflation pressures threaten to the upside and the need for protection becomes more important.
According to Bank of America’s fund manager survey for March, inflation is now the key risk for investors with some 37% of respondents citing this as the biggest concern.
However, Sacha Chorley, portfolio manager at Quilter Investors, said inflation fears may be overdone.
“If you look at market expectations for inflation, it is true that indications are above the 2% target many central banks set,” Chorley continued. “But crucially, it has been a steady increase since 2020 rather than a sharp rise, and the latest drop in markets actually coincided with a decrease in these inflation expectations.
“Indeed, the Fed has not changed its guidance on inflation, so these fears do appear slightly misplaced just now.”