Mar 14, 2017 | Post by: Roman Chuyan, CFA Comments Off on The Recipe For Rising Rates: TIPS

The Recipe For Rising Rates: TIPS

It’s been tough market for bond investors since the last week of February. The odds of the Fed’s rate hike on March 15th jumped from 35% to nearly 100% in three weeks. Longer-term rates also jumped, and bond prices, which are inverse to yields, fell. The Fed officials are compelled to act in part because inflation is rising. As I wrote in my Mar-3rd blog, overall inflation pressures are building, with total CPI inflation now at 2.5%. And with strong February payroll growth of 235,000, the Fed’s March hike is a virtual certainty.

The price drop this year brought 1-year total return for U.S. aggregate bonds (index ETFs include AGG and BND) to zero (see chart). Long-term corporate bonds (+2.5%) fared slightly better, and Treasuries (-2.8%) worse than aggregate bonds. Bond prices and total returns matter to active fixed-income investors (that is, those attempting to do better than holding individual bonds to maturity). They matter even to buy-and-hold investors in bond funds, because funds constantly reinvest.

We recommended avoiding longer-term bonds for most of last year – see the latest Jan-20th summary. The 10-year Treasury trades at 2.6% today, still below our mid-2017 target of 2.8% – so longer-term bonds remain unattractive. But do we need to continue with the low-yield diet?

I’m excited to report that Treasury inflation-protected securities (TIPS) are becoming attractive. I wrote in my “TIPS Are Not On The Menu” blog in December that they seemed expensive around 45 bps real yield. TIPS pay interest adjusted for CPI inflation, and inflation was still around 2% then. Today, the TIPS price drop moved their real yield to 60 bps, and inflation is now 2.5%, so investors expect to earn 3.1% gross nominal yield on TIPS in the near term. This compares well even with higher 2.6% on nominal 10y T-notes, and again, TIPS offer inflation protection which fixed-rate bonds don’t.

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Disclosure: Roman Chuyan is the president and general partner of Model Capital Management LLC, a Registered Investment Advisor. This article is for informational purposes only. There are risks involved in investing, including loss of principal. Roman Chuyan makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Model Capital Management LLC. There is no guarantee that the goals of the strategies discussed in this article will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any security. Asset allocation, tactical asset allocation, TAA, tactical investing, tactical management, ETF, tactical investment management, Financial planning systems for advisors, Financial planning tools for advisors, Financial planning tool for advisors. Envestnet, TD Ameritrade, Adhesion, Best TAMP, SEI Advisor Network, Schwab intelligent portfolios. Betterment institutional, Schwab PortfolioServices, Dynamic wealth advisors. Investor onboarding, Financial planning platforms, Client onboarding for wealth firms, investment management for WM. Investment management for advisors, Schwab performance technologies, SEI Advisor, Ameritrade Adhesion, Best TAMPs. Investment management platform, SEI Asset Management, Schwab Portfolio Services, Investment management platforms. Schwab Portfolio Center, AssetMark, Financial planning system for advisors, Orion Advisor, SEI Practice Management, client onboarding for WM. Financial planning software for advisors, Robo plus, Financial planning platform. Turnkey asset management platform, client onboarding wealth management, SEI Advisor Center, Orion Advisor Solutions, Schwab PortfolioCenter. Robo advisors plus, SchwabPT, Adhesion Wealth, investment management for advisor. Client onboarding for wealth, Turnkey asset management platforms, investment management for advisory, Schwab intelligent portfolio.

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