Revisiting Inflation: Lipper Inflation Protected Bond Funds Remain in Demand

With the market’s focus drawn to the Federal Reserve’s three-day Jackson Hole symposium, I felt it was a good time to revisit the Lipper Inflation Protected Bond Funds classification. Back in April (see article here), we saw the classification log its largest quarterly inflow during Q1 (+$19.2 billion). The funds within the classification did not reward investors just yet, returning negative 0.62% on average throughout Q1.

Before we get to the updated flows and performance, let’s reevaluate the macro-economic environment by looking at three different inflation measures-consumer price index (CPI), producer price index (PPI), and personal consumption expenditures index (PCE).

The U.S. Bureau of Labor Statistics (BLS) reported the July CPI on August 11. The CPI looks at a domestic basket of consumer goods and tracks the prices over time. The CPI rose 5.4% in July from last year, matching June’s increase, which was the largest 12-month increase since August 2008. Core CPI-excluding food and energy-was up 4.3% year-over-year, a slight decrease from June’s 4.5%. Month-over-month, both indices rose-0.5% and 0.3%, respectively.

The BLS released the producer price index a day later. The PPI follows prices at the wholesale level which will indicate the cost of inputs into the production process. The final demand numbers were more jarring than the CPI. The PPI for final demand increased 1.0% month over month in July after rising 1.0% in June and 0.8% in May. The annual increase from last July was 7.8%, denoting the largest spike since the 12-month figures were first calculated in 2010. Core PPI, excluding food and energy, rose 0.9% from June-tying the largest monthly advance this year. Core PPI also set a record for the largest 12-month period increase (+6.1%) ending in July (first calculated in 2014).

Last and certainly not least, we have the PCE. The Bureau of Economic Analysis (BEA) published their July Personal Income and Outlays Report today, August 27. In this report, we can find arguably the most important inflation measure monitored by the Fed, the core personal consumption expenditures price index (core PCE). Core PCE provides a measure of prices paid on a changing basket of domestic goods and services, excluding food and energy.

Although month-over-month core PCE growth was the lowest increase since February (+0.3%), the annual increase from last July remained at 30-year highs (+3.6%)-marking the fourth straight month exceeding the Fed’s 2% target. For reference, the annual percentage change for core PCE only surpassed 1.7% one time last year.

Now that we know the headline numbers, how does the Fed interpret these figures? The July Meeting Minutes gave insight into what sounds like a growing reluctance towards the “transitory” nature of inflation. The notes read,

“However, the staff judged that the risks around the inflation projection were now tilted to the upside, as recent data pointed to a greater risk that the upward pressure on inflation that had resulted from supply-related issues would unwind more slowly than the staff’s baseline projection assumed.”

If data continues to support a more permanent increase in prices, the next move by the Fed will most likely be to slow the asset purchases by the Central Bank. The monthly purchases of $80 billion Treasuries and $40 billion mortgage securities have artificially been keeping borrowing costs low. By ending the program, rates such as mortgage rates may rise again, which will cool off some economic activity with the hopes of easing the upward price pressures.

The notes from the July meeting also state “the staff continued to judge that the surge in demand that had resulted as the economy reopened further had combined with production bottlenecks and supply constraints to boost recent monthly inflation rates.” While supply bottlenecks and an eagerness to travel have certainly caused a “transitory” component for many of the inflationary data points, if and most likely when we see an increase in wages, the “transitory” inflation will start to plant more enduring roots.

The BEA reported real (adjusted for inflation) average earnings for hourly employees decreased 0.1% from June to July and is down 1.2% from last July. This reported monthly percent change has decreased seven straight months, while the 12-month percent change has seen real earnings decreased four consecutive months. The data suggest the buying power for consumers is decreasing, pair that with a declining unemployment rate and you get upward pressure on wages.

Now to the fun(d) stuff. Investors have not cooled on Lipper Inflation Protected Bond Funds since our last writing. The classification has followed up a record-breaking Q1 2021 inflow total with the second-largest quarterly intake to date (+$18.1 billion). Investors were pleasantly rewarded as well; Lipper Inflation Protected Bond Funds recorded the seventh-highest Q2 performance (+2.65%) under all taxable fixed income classifications.

There are no signs of slowing; the classification reported their largest weekly inflow on record for the week ended July 28, 2021 (+$2.2 billion) and is on pace to log their sixteenth straight month with positive inflows. This Lipper classification has only suffered two weeks of net outflows this year. The Fed may taper their asset purchasing by the end of this year as they prepare to raise rates in 2023, but will that be enough to subdue the inflationary demands from the economy? Flows suggest the end-of-year tapering will have little to no effect putting out this fire.

Check out last week’s flow trends here.

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Originally published at https://lipperalpha.refinitiv.com on August 27, 2021.