Gas Prices Boost U.S. Inflation: Time For TIPS ETFs?

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Includes: TDTF, TDTT, TIP, TIPX
by: Zacks Funds

U.S. consumer inflation started off 2017 at a five-year high reading. Inflation rose 2.5% year over year in January 2017, following a 2.1% rise in December and above market expectations of 2.4%. On a sequential basis, the consumer price index grew 0.6% in January, exceeding market expectations and last month's reading of 0.3%.

The inflation rate picked up pace for six months in a row to reach the highest level since March 2012, mainly helped by gasoline prices. On an annual basis, energy prices surged 10.8% in January, following a 5.4% expansion in December. Energy prices have been on an uptrend. The cost at the gas station upped to a nationwide average of $2.30 a gallon from under $2 last spring.

Investors should also note that multi-year low oil prices for about two years have been one of the key reasons for subdued global inflation. Now, with OPEC deciding on a production cut from early next year for six months, a certain uptick in oil prices has been realized from the year-ago level.

In any case, the U.S. inflationary outlook recently got a boost on Donald Trump's win in the presidential election. Trump's proposed $1 trillion spending plan and a slash in personal and corporate taxes have injected fresh optimism in the otherwise decent U.S. inflation.

Food costs, which remained the same for six consecutive months, nudged up 0.1%. Barring food and energy, prices advanced 0.3%, which is above 0.2% recorded in the prior two months and surpassing expectations of 0.2%. In fact, Fed Chair Yellen also indicated that inflation is no longer "at very low levels."

Party Time for TIPS ETFs

TIPS offer robust real returns during inflationary periods, unlike their 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. As a result, both principal amount and interest payments will keep on rising with increasing consumer prices.

This mechanism has made TIPS ETFs investors' darlings in recent times, as they are increasingly wagering on these inflation-protected bond ETFs. The iShares TIPS Bond ETF (NYSEARCA:TIP) was one of the biggest beneficiaries of this trend, having hauled in $558.8 million so far this month (as of February 16, 2017), according to data compiled by etf.com.

As per an article published on Bloomberg, iShares' $22 billion TIPS ETF attracted about $6 billion - the second-largest gain of all bond ETFs in 2016 - and advanced about 3.6%, the highest in three years.

In this regard, investors should take note of TIPS ETFs, including the FlexShares iBoxx 5-Year Target Duration TIPS Index ETF (NYSEARCA:TDTF), the FlexShares iBoxx 3-Year Target Duration TIPS Index ETF (NYSEARCA:TDTT) and the SPDR Barclays 1-10 Year TIPS ETF (NYSEARCA:TIPX).

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