(Investor's Business Daily) - Soaring inflation and realized/anticipated interest rate hikes recently ended the 40-year bull market enjoyed by bonds, causing deep drawdowns for investors holding high fixed-income allocations.
Year-to-date, the yield on the benchmark 10-year Treasury note has jumped by over 74%, hitting a 52-week high of 3.167% briefly1. The post-Memorial Day trading session on May 31 saw a 3.68% increase in the 10-year alone, sending Treasury prices on a rout as equities tanked in unison.
Inflation continues to run high, with consumer prices jumping 8.3% in April year-over-year (YoY) because of soaring commodity prices exacerbated by the global supply-chain disruption and the ongoing Russian invasion of Ukraine2.
TIPS Offer Inflation Protection
Some traders see opportunity in Treasury Inflation-Protected Securities (TIPS).
TIPS are indexed to help protect portfolios from a sudden, unexpected surge in inflation. As prices rise, the principal is adjusted higher over time. Therefore, they can help tactical investors seek to avoid higher-than-expected inflation risk, which can seriously erode the yield on traditional fixed-rate Treasurys.
Key Catalysts to Watch For When Trading TIPS
Those looking to trade TIPS likely need to stay abreast of two main economic indicators: the size of anticipated interest rate hikes and monthly inflation figures.
TIPS are still affected by changes in the Fed Funds rate3, with duration measuring the move in its price as a function of interest rate changes. The two have an inverse relationship. For example, if rates are expected to increase by 1%, a TIPS with a duration of two years is expected to lose about 2% of its value, and vice versa.
The Federal Open Market Committee (FOMC) has reaffirmed its stance to commit to a series of 50 basis-point rate increases throughout its June and July meetings. Policymakers are expected to wait and assess summer inflation figures before deciding on the size of further hikes in September.
Traders can also use TIPS to protect against high, unexpected inflation or short TIPS to hedge against lower-than-expected inflation. This is because the TIPS market has historically been relatively efficient at pricing in near-term inflation with good accuracy.
Inflation figures such as the monthly consumer price index (CPI) releases and the personal consumption expenditure (PCE) report (the Fed's preferred gauge of inflation) should be observed closely. The next PCE release is scheduled for June 30th. The June CPI report is slated for July 13th at market open.
The latest PCE report showed a 4.9% year-over-year increase for April, compared to a 5.2% increase in March4. Although small, this may be evidence that inflation has begun to peak. Investors should pay attention to the market's consensus for the next release, along with monthly YoY CPI figures.
How To Trade TIPS With Direxion's ETFs
Traders seeking increased exposure to the TIPS market for speculation or hedging purposes can consider using Direxion's Daily TIPS Bull (TIPL) and Bear (TIPD) 2X Shares.
TIPL and TIPD seek daily investment results, before fees and expenses, of 200%, or 200% of the inverse (or opposite), of the performance of the Solactive TIPS ETF Index for a single day. There is no guarantee the funds will meet their stated investment objective. The funds should not be expected to provide two times or negative two times the return of the benchmark's cumulative return for periods greater than a day.
Traders with a bullish outlook can buy TIPL to go long if they think TIPS prices will go up. Conversely, traders with a bearish outlook can buy TIPD to go short if they think TIPS prices will drop.
A strategy that employs both ETFs based on technical momentum indicators and trading around economic releases might help the tactically-minded manage their risk and produce returns no matter which direction the TIPS market goes. However As with all Daily Leveraged and Inverse ETFs, they can be powerful ways to magnify short-term exposure — but only if you do your due diligence on their underlying holdings, have a strong investment thesis on the outlook for the Treasurys market, and have a high risk tolerance.
Definitions:
CPI - The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
Federal Funds Rate - The federal funds rate is the target interest rate set by the FOMC. This is the rate at which commercial banks borrow and lend their excess reserves to each other overnight.
PCE - Personal consumption expenditures is a measure of consumer spending.
Solactive TIPS ETF Index - (SOLTIPET) provides exposure to the iShares TIPS Bond ETF, which seeks to track the investment results of an index composed of inflation-protected U.S Treasury bonds, commonly known as "TIPS." TIPS are securities issued by the U.S. Treasury that are designed to provide inflation protection to investors. One cannot directly invest in an index.
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iShares is a registered trademark of BlackRock, Inc. or its subsidiaries ("BlackRock"). Neither BlackRock nor the iShares Funds make any representations regarding the advisability of investing in the Fund.
The Funds are not suitable for all investors and are not appropriate for investors who do not intend to actively monitor and manage their portfolios.
Direxion Shares Risks – An investment in the Fund involves risk, including the possible loss of principal. The Fund is non-diversified and includes risks associated with the Fund concentrating its investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of the Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Daily Index Correlation Risk, and Other Investment Companies (including ETFs) Risk, and risks specific to inflation-protected U.S. Government securities, including interest rate risk, credit risk, and deflation risk.
The value of inflation protected securities, including TIPS, generally will fluctuate in response to changes in "real" interest rates, generally decreasing when real interest rates rise and increasing when real interest rates fall. Real interest rates represent nominal (or stated) interest rates reduced by the expected impact of inflation. In addition, interest payments on inflation indexed securities will generally vary up or down along with the rate of inflation. Please see the summary and full prospectuses for a more complete description of these and other risks of the Fund.
June 27, 2022
