In recent months we have been buying 0-5 year US inflation-linked bonds (TIPS) as a defensive move to get exposure to the US dollar.
At the time of purchase, we viewed the US bond market as still offering little value against a background of further monetary tightening by the Federeal Reserve.
In addition, we felt that the market was being complacent in terms of what was being discounted for future inflation. The break-even rate of inflation, nominal yields minus real yields on TIPS, was pricing future US inflation at a little over 2% – i.e. the Fed’s target rate.
With the US economy re-accelerating from the Q1 slowdown, as well as an increasingly tight labour market and additional economic fuel from tax cuts, we anticipate US inflation to peak nearer to 2.75% than the 2% target. This suggested to us at the time that there would be further upside for US yields as the Fed continues to raise short-term interest rates to 3% from the current 1.75%.
In summary, our investment in short-dated TIPS was gaining dollar exposure with some inflation protection.