The Pullback Signals Confidence in Fed’s Inflation Control, Leading to Less Demand for Inflation-Protected Securities

The once-popular inflation hedge of the pandemic era is rapidly losing its appeal, as the largest US exchange-traded funds (ETFs) focused on inflation-linked bonds have seen their assets shrink dramatically. From a high of more than US$99 billion in early 2022, these ETFs, which invest in Treasury Inflation-Protected Securities (TIPS), have plunged to around US$57 billion, a level not seen since late 2020, before inflation surged.

This decline highlights how investors are becoming increasingly confident that the Federal Reserve has successfully tamed inflation. As of February 13, 2024, economists expect the annual increase in the consumer-price index (CPI) to drop below 3%, marking the first time in nearly three years that the inflation rate has been so low. Just a year and a half ago, in June 2022, inflation was running at nearly 9%, about three times the current rate.

The pullback in TIPS ETFs reflects growing optimism that the Fed will continue its efforts to manage inflation, with some expecting interest rates to begin dropping this year. With the soft-landing outlook taking hold, the demand for inflation protection has significantly diminished, as Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management, noted. “The need for inflation protection has been lessened,” she said.

However, the decline in assets also signals that TIPS ETFs have not performed as well as expected as an inflation safeguard, leaving some investors rethinking their inflation-hedging strategies.