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 But some voices - including a few at the policy-setting Federal
Reserve - are suggesting consumer inflation could take off faster
than expected.
If oil reverses its recent steep decline and wages begin to move up
in response to a tighter labor market, inflation could once again
become a factor for investors to reckon with.
Some investors already are preparing for that reckoning. Some big
financial firms, including BlackRock Inc <BLK.N>, are telling their
clients to hedge against inflation by buying funds that hold
Treasury Inflation Protected Securities, or TIPS.
These bonds, along with consumer-facing I-Bonds, peg some of their
interest to the Consumer Price Index (CPI). So as inflation speeds
up, holders of those bonds earn enough interest to keep up with it.
Investors have poured $2 billion in new money to TIPS exchange
traded funds in the last 16 weeks.
That may be an obvious bet: currently, 10-year TIPS are priced,
relative to plain vanilla Treasuries, in a way that would reward
investors should CPI inflation over the next 10 years top 1.57
percent. The Federal Reserve is targeting 2 percent inflation over
next two years.
That makes TIPS seem like a slam dunk. With New York oil futures
trading at around $38 per barrel, it is hard to imagine a world
where U.S. consumer prices will not rise by more than 1.57 percent.
But think twice before you jump in with both feet - and your
retirement account. The following are some of the downside risks you
take when you bet on inflation with TIPS:
* Protection is limited. TIPS funds may jump quickly in value if
investor sentiment starts to reflect big inflation expectations, but
they rarely reward investors over time for sustained inflation. At
best, they merely pace the CPI with a lag, so you can protect the
amount of money you have in a TIPS fund from the effects of a rising
CPI. They are not going to overcompensate.
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To hedge against a big and sustained pickup in prices, you are
better off investing in stocks of companies that really jump during
times of inflation, such as energy and real estate. Since 1970, the
stock market sectors that have performed best during months of
rising consumer prices are energy, information technology, materials
and healthcare, according to Sam Stovall of S&P Global Market
Intelligence.
* There is a worst-case scenario. Like all other bonds, i-bonds lose
value when interest rates go up. Should interest rates rise faster
than inflation does - expanding what economists call "real rates" -
holders of TIPS may get slammed. And because their bonds currently
are lower-yielding than Treasuries of comparable maturities, they
will become less valuable as rates rise, and not be cushioned by any
rising-CPI payouts.
* You have to plan around a tax hit. Even if you hold your TIPS and
TIPS funds for years and years, you will be liable for federal
income taxes on the income you earn every year, including the
increase in value of the bond should rates fall. That means that if
you decide to invest in them, you should do so from within a
tax-favored account, such as an individual retirement account or
401k.
* You might be betting wrong. Though TIPS currently are favorably
priced, it will take a global economic surge and a recovery in oil
prices before there is any big jump in inflation, according to Bill
Shackelford, portfolio manager of the T. Rowe Price Inflation
Protected Bond Fund.
"I don't think we're in the midst of a forced march to higher
inflation anytime soon," he said.
(Editing by G Crosse)
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