20 Apr 2020

Looking for TIPS?

The current economic downturn has created a supply/demand shock that has triggered a global response, unlike anything we have seen before. The COVID-19 public health crisis has quickly turned into a worldwide economic emergency as Governments and central banks from around the world launch unprecedented amounts of monetary and fiscal stimulus.

In response to the virus, forced business closures are resulting in mass layoffs and economic growth grinding to a halt. There is little doubt that rising unemployment and the cocooning consumer will lead to a reduction in spending. As demand falls, oversupply results in downward pressure on prices, increasing the risk of deflation. Perhaps the fallout of COVID-19 will encourage individuals to build up emergency savings funds?

However, given the extreme measures already taken by Governments and central banks, it is easy to consider monetary and fiscal policies remaining accommodative long after COVID-19. With blowout spending driving up budget deficits and record amounts of money printed, it seems that future inflation is probable.

Why didn’t the stimulus from 2009 create inflation? There are two reasons. First, it was concentrated in;one sector (the banks), whereas today’s stimulus is distributed much more broadly. Second, China has been a deflationary force over the past decade and is relatively neutral now.

The coordinated ‘what-ever-it-takes’ stance implemented by global governments and central banks to mitigate the coronavirus crisis is likely to have inflationary consequences in the long-term.

BCA Research

Treasury Inflation-Protected Securities (TIPS) are inflation-protected bonds issued by the US Treasury. In Canada, we have Real Return Bonds (RRB) and current inflation expectations are low. Consider this, the ~5Y RRB and ~10Y RRB carry breakeven inflation rates of 0.25% and 0.55%, respectively. A buy-and-hold investor will outperform holding RRBs versus nominal bonds if inflation averages more than 0.25% per year for the next five years or 0.55% for the next ten years.

This is an investment we are willing to make.