Connecting the Dots

The Uncomfortable Increase in Inflationary Warning Signs

April 5, 2016

“We may well at present be seeing the first stirrings of an increase in the inflation rate.”
—Stanley Fischer, Vice-Chairman, Federal Reserve

There should be an “immediate increase in rates.”
John Williams, President, Federal Reserve Bank of San Francisco

“I think the evidence indicates that inflation expectations remain well anchored. I am reasonably confident that, barring subsequent shocks, inflation will move back to the FOMC’s 2% objective.”
— Jeffrey Lacker, President, Federal Reserve Bank of Richmond

Are interest rates headed higher?

If you believe Janet Yellen’s ad nauseam promises that the Federal Reserve’s decision to increase interest rates is totally “data dependent,” then you should expect interest rates to move higher.

I say that because of the line of data points pointing toward an uncomfortable increase in inflation.

The Atlanta Fed’s measurement of what it calls “sticky price” inflation jumped to a post-Financial Crisis high of 3% in February. This index is a measure of core inflation.

What’s more, the Cleveland Fed reported that its CPI index jumped to 2.9%—largely from big price increases in medical services, housing rents, car insurance, restaurants, hotels, and women’s clothing.

Inflation was nowhere to be found for years, but the evidence is mounting that we are at an inflation inflection point.

Our economy is already fragile, but I want you to remember that economic expansions seldom die of old age. Instead, they are killed by idiot central bankers. In fact, every major US recession since World War I has been caused by the Federal Reserve attempting to kill off inflation.

I have no reason to think that Janet Yellen and her Fed buddies are any smarter than our previous central bankers, so my expectation is for them to screw things up like their predecessors always have.

When that happens, income investors with a big weighting of long-term bonds are going to get clobbered. Fortunately, there is a new breed of ETFs designed to prosper when interest rates are rising:

iShares US Treasury Inflation Protected Securities ETF (TIP): This ETF invests in US government bonds whose value adjusts with inflation.

ProShares Investment Grade—Interest Rate Hedged ETF (IGHG): This ETF invests in investment-grade bonds while adopting short positions in US Treasury bonds of approximately the same duration. This ETF seeks to achieve an overall duration of zero.

SPDR Citi International Government Inflation-Protected Bond ETF (WIP): This ETF buys inflation-protected bonds issued by foreign governments, such as the UK, France, Italy, Sweden, Brazil, Turkey, Australia, Canada, and Mexico.

Sit Rising Rate ETF (RISE) is an ETF designed to profit from increases in short-term interest rates. This ETF shorts the shorter end of the yield curve, which are the bonds most affected by Federal Reserve rate hikes.

As always, timing is everything, so I’m not suggesting you rush out and buy any of these ETFs tomorrow morning. But if you’re worried about a return of inflationary pressures and Fed rate hikes, the above ETFs are worth your consideration.

Also, check out my monthly newsletter Yield Shark where I recommend the best dividend-paying stocks with inflation-beating yields and great upside.

Tony Sagami
Tony Sagami

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