April 30, 2021

Inflationary Pressures Boiling Up Cause Hot Streak in Inflation Protected Bond Funds

by Jack Fischer.

A few weeks ago, we touched on Lipper Loan Participation Funds and how the recent rise in yields has led to a significant increase in weekly net flows. Today, we pivot and dive into the Lipper Inflation Protected Bond Funds classification.

The Lipper Inflation Protected Bond Funds classification—including both conventional mutual funds and ETFs—realized a quarterly record of inflows in Q1 (+$19.2 billion) despite a negative Q1 return on average (-0.62%). For context, their average quarterly net flow dating back to 2003 is positive $1.7 billion. This Lipper classification saw net outflows this past fund-flows week for the first time in 28 weeks, ending the longest streak since the start of 2008 where they witnessed 70 straight weeks of inflows.

For more flow trends, check out the U.S. Weekly FundFlows Insight Report.

The Lipper Inflation Protected Bond Funds (IUT) classification is defined as funds that invest primarily in inflation-indexed fixed income securities. These funds are structured to provide protection against inflation. The economy heating up with inflation has been a hot topic for the markets since the CARES Act provided $2.2 trillion in economic stimulus back in March 2020. Since then, President Joe Biden has rolled out the $1.9 trillion coronavirus relief package as well as introduced a $1.8 trillion dollar America Families Plan. When an increasing amount of capital is injected into the markets, we often see input prices rise, which when passed on to the consumer means that our dollar does not necessarily afford us the same amount as before.

Trillions of dollars have been injected into economy causing inflationary worries.
Source: Board of Governors of the Federal Reserve System (US)


According to the Bureau of Labor Statistics, the CPI increased 0.6% in March—the largest one-month increase since August 2012. The increase was mainly attributed to the rise in the gasoline and natural gas index (+9.1% and +5.0%, respectively). The Chair of the Federal Reserve, Jerome Powell, has acknowledged the rise in prices, but suggests they are “transitory” as our economy reopens. Job numbers also play a role in the Fed’s policies. If the labor market tightens to where there are more job openings and fewer unemployed people, upward pressure on wages can ensue. Upward pressure on wages can create upward pressure on prices and around and around the cycle can go.

With all the inflationary concerns boiling in the market, how can investors gauge the temperature of inflation expectations? Well traditionally, the break-even inflation rate has been one indicator of future inflation expectations. The break-even inflation rate is the difference between the nominal yield of a fixed rate investment and the real yield of a comparable inflation-linked investment. The average 10-year break-even over the past 15 years is 2.01%. Over the past two years it is 1.67%. As of April 28, the 10-year break-even is 2.41%—a 17% increase since the start of the year and a 151% increase since the second week in March. 2020.

As the 10-year break-even inflation rate increases, net inflows persist into inflation protected bond funds.

Much like 2008, weekly net inflows tell us investors are piling into Lipper Inflation Protected Bond Funds. As these inflationary pressures continue to surround the economy, flows will most likely persist into this classification. The question becomes whether the price jumps will be temporary spikes of demand as the world slowly reopens. Or are we destined for a more permanent higher cost of living?

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