* Rising cost of shelter helps stir demand
* Investors putting cash to TIPS for first time in 2 years
* Inflation bonds outperforming other Treasuries
By Richard Leong
NEW YORK, Sept 1 U.S. investors are back in the
hunt for inflation protection for the first time in two years as
rising housing costs - particularly for rent - suggest inflation
may finally be waking from its post-recession slumber.
That's helping to drive cash into specialty funds that focus
on Treasury Inflation Protected Securities, or TIPS, arguably
the weakest corner of the U.S. government bond market over the
previous year or so, and helping TIPS significantly outperform
regular Treasuries this year.
TIPS-focused funds are on pace to end seven consecutive
quarters of outflows over which investors drained almost $38
billion from the sector. They've attracted $1.52 billion so far
in the third period, marking the first quarterly inflows since
the third quarter of 2012 and the largest since the first
quarter of 2012.
Fund managers said the rising cost of housing - which
accounts for as much as a third or more of various measures of
inflation and is outpacing other consumer cost increases - has
revived price pressure in the economy.
"TIPS have had a good tail wind this year. We have inflation
as opposed to last year when we had disinflation," said Gemma
Wright-Casparius, who oversees Vanguard's $26.3 billion
inflation-protected securities fund, the biggest U.S.
fund of its kind. The fund is up 6.5 percent this year.
Wright-Casparius also helps manage a short-dated TIPS fund
whose assets have reached almost $10 billion since it launched
nearly two years ago.
BETTING ON INFLATION
Inflation will likely creep higher in the coming months,
according to a Reuters poll of economists. The Consumer Price
Index has risen at 2 percent year-over-year for four straight
months now and is forecast to accelerate to 2.2 percent later
this year and into 2015, the data shows.
This outlook along with the possibility the Federal Reserve
will raise interest rates in the middle of 2015 make TIPS a
sensible choice, bond managers said. Also, the fact that Fed
Chair Janet Yellen has signaled a willingness to let inflation
run a bit hot relative to the central bank's target is also a
positive, because the principal of a TIPS bond increases with
U.S. inflation bonds have produced a return of 6.35 percent
since January, about 3 percentage points more than regular
Treasuries, according to indexes compiled by Barclays.
In 2013, TIPS suffered their worst year since they were
introduced in 1997, posting an annual loss of 8.61 percent
compared with a decline of 2.63 percent for the broader Treasury
To be sure, it may be difficult for TIPS to sustain their
"I think it's going to be much more challenging for them to
generate returns as high as they have been in the past year or
year to date," said Bill Irving, a Merrimack, New Hampshire,
portfolio manager for Fidelity Investments, which manages $2
That's because a sizeable portion of their gains this year
are the result of an unexpected collapse in "real yields," or
yields as measured against inflation. This proxy on the market's
view on economic growth came after a stunning 2.9 percent drop
in gross domestic product in the first three month of the year
followed by a second-quarter 4.2 percent pop.
The real yield on 10-year TIPS, which move inversely with
their price, tumbled from 80 basis points early in the year to
20 basis points recently. Shorter-dated real yields are actually
negative, with inflation outstripping nominal yields.
A dramatic rally in bond markets worldwide, dragging U.S.
yields back to their lowest levels in more than a year and
yields on some European sovereign bonds to their lowest ever,
further supported TIPS' revival. It is unclear, though, just how
much more steam it has.
A variety of factors behind the rally include demand for
low-risk sovereign bonds in face of conflicts in Ukraine and the
Middle East and negative yields across the Atlantic where
European Central Bank is expected soon to embark on new steps to
avert Japanese-style deflation.
Ever since the housing market collapsed during the mortgage
crisis seven years ago, more Americans have become renters,
driving up demand for apartments and boosting rental costs.
A measure of that, known as owners'-equivalent rent, makes
up 31 percent of the so-called core CPI. It was up 2.9 percent
year-over-year in July, and a related measure of rent rose 3.2
percent, its fastest annual pace since March 2009. This trend
could accelerate in the coming year, said Martin Hegarty,
co-head of Blackrock's global inflation-linked $25.5 billion
portfolio in New York, which has gained 6.22 percent
"We are looking at shelter inflation in the next 12 to 18
months to touch the high 3 percent, maybe even 4 percent,"
Hegarty said. "That provides a relative stable base for
everything else to build on top of."
A risk is that as rent and prices for food and other
essentials rise higher, household spending more broadly could be
pressured given the limited gains seen in the most widely
tracked measures of wages.
But these fund managers say an underlying measure of wages,
for private sector production and nonsupervisory employees, has
been gaining ground at a faster clip, signaling consumers should
be able to absorb higher costs.
Still, one signal from the TIPS market implies investors
remain skeptical about wages and prices going much higher.
TIPS' breakeven rates, the differences between the yields on
TIPS and nominal Treasuries and gauges of investors' inflation
expectations, have fallen since the start of the year. The
10-year breakeven rate was 2.13 percent on Friday from 2.33
percent in early January.
Bond managers said the data will soon catch up their view
and further declines in breakeven rates in the near term would
offer investors cheaper levels to position for bigger profits in
the long run.
"Ultimately, U.S. economic fundamentals will prevail and put
upward pressure on rates but it could be some time before it
takes hold," Fidelity's Irving said.
(Reporting by Richard Leong; Editing by Dan Burns and John