Funds that hold inflation-protected bonds are enjoying their longest streak of inflows in more than a decade, as investors gird themselves for an increase in consumer prices as the US economy recovers.

Another $1.2bn flowed into funds that buy US Treasury Inflation-Protected Securities, or Tips, in the week ended Wednesday, according to data provider EPFR — the 29th consecutive week of net inflows. That took the total for the year to date to $14.4bn.

The current run of inflows is the longest such stretch since the aftermath of the global financial crisis, when Tips funds recorded uninterrupted growth from December 2008 to early 2010.

“Inflation is the number one concern,” said Collin Martin, a fixed-income strategist at Charles Schwab. “[Tips] are not going to give you great yield or return potential, but if you are worried about a significant upside surprise in inflation, there is really no better investment out there that can act as a hedge.”

Column chart of Weekly flows into US funds buying inflation-protected securities, $bn showing Economic rebound spurs elevated demand

Markets have focused intently on the prospects for inflation since the first signs in November that the global coronavirus vaccination campaign would progress more quickly than anticipated.

The Biden administration’s $1.9tn fiscal stimulus programme, passed in March, further fuelled predictions of higher prices to come, with noted economists including former Treasury secretary Larry Summers warning about the risks of the world’s largest economy overheating.

The Federal Reserve’s favourite inflation gauge — Core PCE — was 1.4 per cent in February and policymakers have committed to keep monetary policy ultra-accommodative until it averages 2 per cent.

Fed chair Jay Powell and other central bank officials have argued any increase in price pressure will be “transitory” and likely to fade as supply chains adjust to surging demand. 

Popular market measures of inflation expectations indicate Wall Street broadly subscribes to that view. Two-year and five-year break-even rates, which are derived from Tips and predict inflation in two and five years, now hover at 2.63 per cent and 2.57 per cent, respectively, having both been below 2 per cent in December. The 10-year gauge is lower, however, at 2.3 per cent.

Line chart of Long-term inflation expectations have not risen nearly as fast as those for the short term showing 'Transitory' price rises?

As break-even rates have risen, longer-dated Treasuries have sold off, since those bonds’ value is eroded by inflation. That sent the 10-year Treasury yield up from below 1 per cent at the start of the year to a peak of 1.78 per cent. It now sits at 1.55 per cent.

Investment strategists expect strong economic growth and inflation to push it even higher: forecasts compiled by Bloomberg point to a year-end yield of 2 per cent.

“Transitory [inflation] can move markets,” said Alexandra Lawson, a fixed income portfolio manager at Goldman Sachs Asset Management. “That in itself can lead to higher inflation expectations.”

She added: “If you believe that inflation expectations lead to more permanent inflation, you can help offset that in Tips exposure.”

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