Bleak Global Inflation Backdrop: Sell TIPS ETFs?

Most of the global economy, especially the developed part, feels threatened by deflationary worries.  While the Euro zone and Japan have been striving hard to boost their money supplies and pull their respective economies out of the deflationary trap, several emerging markets, often facing severe inflationary pressure, have proved lucky this year to log rather contained inflation data thanks mainly to the fast-falling oil prices.

Bleak Inflation Backdrop of Developed Markets

The U.S., Euro zone and Japan seek to attain an inflation rate of 2% in the near term. Among these, the U.S. has recently closed its six-year long QE program, though the central bank is still maintaining the near-zero interest rate policy.

The U.S. perhaps proceeded to some extent in attaining the inflation target as evident by the 1.7% rate recorded in October. The U.S. hit a 2% mark in July but only to see a decline of 30 bps in the month that followed thanks to declining energy prices.

Euro zone inflation has been a cause of concern for long and was registered at 0.3% in November. Though the ECB gets itself prepared to launch a massive stimulus program, (reportedly), after failing to kick start the inflation engine via other accommodative measures, oil prices appeared as a dampener (read: Euro Zone Gets QE Hints, 3 ETFs to Buy on Stimulus Hopes).

Japan has also been witnessing a decline in inflation for the last three quarters in a row. As per the latest data, Japan inflation was recorded at 2.9% in October (read: 2 Hedged Japan ETFs to Buy After the Surprise BOJ Stimulus).

A look at Emerging Markets

A slump in oil prices gave a big-time boost to the so-far-suffering Indian inflation which slipped to 5.52% in October whereas the indicator averaged 9.23% from 2012 to so far in 2014. Notably, India is a huge importer of energy. The story is the same in China, the world's second largest economy, where inflation eased to the five-year low of 1.4% in November. 

Blow to TIPS ETFs

TIPS offer robust real returns during inflationary periods, unlike its unprotected peers in the fixed-income world. These securities pay interest on an inflated-principal amount (principal rises with inflation) and when the securities mature, investors get either the inflation-adjusted principal or the original principal, whichever is greater (read: Forget Inflation Fears with These TIPS ETFs).

Thanks to this very mode of operation, these bonds and related ETFs have fallen out of investors' favor lately as inflationary pressure does not seem an immediate concern; rather most nations are mulling over the measures that can stave off deflationary threats.

Last week, the TIPS ETF world witnessed the biggest weekly outflow in over a year, as noted by barrons.com. Not only this, the week marked the 13^th successive week of TIPS ETF outflows. In the past one month, returns were poor in this space with most ETFs going into the red, especially the international ones. We have highlighted a few TIPS ETFs below that were hit hard and could be avoided if the global inflationary outlook remains weak.

ETFs to Watch

Global Advantage Inflation-Linked Bond Strategy Fund (ILB) was punished the most both in the period of a week and a month having lost about 0.7% and 1.22%, respectively. Others that have shed in the past one month are iShares International Inflation-Linked Bond ETF (ITIP), Short-Term Inflation-Protected Securities Index Fund (VTIP), iBoxx 3-Year Target Duration TIPS Index Fund (TDTT) and iBoxx 5-Year Target Duration TIPS Index Fund (TDTF).

However, among the lot, 15+ Year U.S. TIPS Index Fund (LTPZ) fared the best with 1.5% one-month gains and 2.5% one-week gains (as of December 9, 2014). This makes sense, as long-term U.S. Treasury bonds could be in favor next year as the Fed hikes short-term rates, assuming that there isn't a big spike in long-term yields as well.

So, investors convinced about the solid long-term U.S. inflation outlook, can try this product, though we believe that as long as the oil rout continues, it is better not to foray into the TIPS ETFs space for now.

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PIMCO-GA ILBETF ILB: ETF Research Reports
 
VANGD-ST TIPS (VTIP): ETF Research Reports
 
PIMCO-15+Y TIPS LTPZ: ETF Research Reports
 
ISHARS-INT ILB ITIP: ETF Research Reports
 
FLEXS-IB 5Y TAR TDTF: ETF Research Reports
 
ISHARS-TIPS BD TIP: ETF Research Reports
 
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