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Morningstar’s Top Picks for Inflation Protection

December 13, 2016

Morningstar’s Top Picks for Inflation Protection

By Christine Benz | 12-07-16 | 05:00 AM | Morning Star

Surveying the fund and ETF landscape, from direct hedges like TIPS to indirect inflation-fighting plays such as floating rate loans and commodities.

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Over the past decade, many investors have learned some hard lessons about attempting to predict the direction of inflation. In the wake of the financial crisis, many pundits believed that the Federal Reserve’s accommodative interest-rate policy would lead to runaway inflation. But sluggish global growth was an even more powerful force, and the U.S inflation rate has languished: The most recent reading, through October 2016, was just 1.6%. That was higher than previous readings, but well below historical norms and the Federal Reserve’s target of 2%.

Yet financial markets are sending signals that inflation could be more of a concern in the future than it has been in the recent past. President-elect Trump’s stated preferences for tax cuts, looser regulations, and infrastructure spending have prompted a rally in stock prices, but bonds have sunk on concerns that those policies could lead inflation, as well as interest rates, to soar.

To illustrate investors’ heightened concern for inflation, the differential between the yield on a nominal (i.e., one that’s not inflation-adjusted) 10-year Treasury bond and the yield on a 10-year Treasury Inflation-Protected Security has jumped since Trump’s election. That differential, often referred to as the break-even rate because it means that inflation would have to advance by at least that much for the TIPS investor to be better off than the buyer of non-inflation-protected bonds, jumped from 1.71 on Nov. 7 to 1.97% just three weeks later.

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