Tag Archives: inflation

Retired Money: Do Inflation-linked Bonds make sense in an era of rising interest rates?

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My latest MoneySense Retired Money column, which has just been published, can be found by clicking on the highlighted headline here: Do inflation-linked bonds make sense in an era of rising interest rates?

The topic is one that until mid 2021 received relatively scant attention: Inflation-linked Bonds and/or ETFs that own them. In Canada, these are called Real Return Bonds (RRBs) while their equivalent in the United States are called Treasury Inflation Protected Securities (TIPS). There are ETFs trading both in Canada and the US that let users own baskets of these securities.

Of course, inflation didn’t seem to be a huge issue for investors until around the summer of 2021 and then the fall, when suddenly the headlines were full of ominous new levels of inflation not seen in years or decades.

These days, traditional non-inflation bonds, or “nominal” bonds famously pay very little in interest, and net returns net of high inflation can easily end up being negative. The idea with RRBs or TIPS is that If inflation ticks above certain levels, such bonds or ETFs holding them  tack on extra interest payments roughly commensurate with the rise in the official inflation rate.

Inflation plus Rising Interest Rates

But the column addresses the question of what if the longer-term bonds held in these funds inflict capital losses when interest rates spike at the same time? That’s the problem with some Canadian RRB ETFs that hold too much in long- or mid-term bonds, and most of them do. 2021 was not a good year for funds like the iShares Canadian Real Return Bond Index ETF (XRB) or the BMO Real Return Bond Index ETF (ZRR), which lost almost 5% in the first nine months of 2021, but ended the year slightly positive.

This is less of a problem if you hold RRBs directly: Real Return Bonds issued by Ottawa have long maturities, ranging from five years out to 30 and even 40 years out. I use to own some of these directly, listed as Government of Canada Real Return Bonds, maturing in December 2021 .When I tried to find a new series at RBC Direct Investing, none seemed to be available online. I discovered you can buy newer issues by calling the discount brokerage’s bond desk. The column describes one maturing in 2026 [which I ultimately purchased, although it is now slightly under water] and a second in 2031.

US TIPS ETFs hedged to Canadian dollar

But if you want to diversify through funds, minimize interest rate risk and get exposure to both RRBs and TIPs, there’s a lot more choice with US-traded TIPS ETFs like the Vanguard Short-term TIPS ETF [VTIP], which hold mostly short-term bond maturing in under five years. Continue Reading…

Canadians worried about Inflation’s impact on their retirement savings, Questrade survey finds

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It’s here, it’s not going away anytime soon, and every time you open a business news article, the word leaps out at you: “inflation.”

And, according to a recent Leger survey commissioned by Questrade of 1,547 Canadians, it’s not only very much top of mind for us, but it’s keeping many of us awake at night: not just about the short-term scenario, but also when we contemplate our retirement future.

According to the survey, four in five (84%) Canadians say they are worried about inflation, with almost two in five (39%) saying they are very worried.

For the short term, most of the Canadians surveyed are concerned about the everyday costs associated with rising inflation. More than eight in ten (86%) who are apprehensive about rising inflation say what worries them most is the increasing cost of food, while nearly as many (82%) are concerned about the increasing cost of everyday items. And not far from mind is the impact of inflation on savings and investments: 45% of those surveyed expressed concern about how inflation would affect their savings and investments, with 51% of those who are investing for their retirement saying this.

Investors are less worried about inflation than non investors

However, while many Canadians are experiencing inflation angst to varying degrees, those taking steps to invest for their retirement appear to be in a better overall frame of mind than those who aren’t. In the Questrade survey, of the 39% who say they are very worried about inflation-related costs, the worry is less with those investing for retirement (36%), compared to those not investing (49%). In particular, those holding an investment vehicle such as a mutual fund, RRSP, or TFSA appear to be consistently less worried about rising inflation than those not holding these products.

For those who are concerned about the longer-term impact of inflation on their investments and retirement, 39% are worried about the cost of living when they retire, followed closely by 38% who are concerned about lower purchasing power.

What’s interesting is that, despite their inflation anxieties, only one quarter of Canadians (23%) have made a change to their investments to safeguard themselves from possible inflationary effects. The remaining 77% either don’t know or haven’t made any change.

Of those who are making changes to their investments due to inflation, 24% are planning on contributing less while 22% are going to contribute more this year. The survey revealed that among those with an RRSP, 39% say they plan on contributing more to it this year, especially those aged 18–34 (57% vs. 36% for those aged 35+), with an average of about $5,409 extra. The reasons for contributing more to their RRSP vary, but for nearly half, it’s because retirement is a priority for them. Continue Reading…

Inflation and Central Banks: Like having a Friend climb a Ladder

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

Various people have asked me to weigh in on our inflation situation with a particular focus on what central bankers should do about rates going forward.

The ‘what to do’ elements include queries about when to hike, how much, how often and to what end.

I like to use metaphors and the one that fits here is one of having someone you care about climbing a ladder.  In this scenario, the ‘friend’ is a mashup of the economy and markets (specifically, both the stock market and the real estate market), the ascension up the ladder is the seeming inexorable climb of prices and valuations, and the decision to tip the ladder over is the decision to raise rates.  Here’s the problem …

Let’s say someone you care about is climbing a ladder and you have been given the task of holding the ladder steady, stable, and firmly rooted on the ground while that person climbs.  In this case, “price stability” equals “ladder stability.” It’s a tall ladder and conditions are becoming increasingly perilous.  As your friend ascends, it eventually becomes clear to you that communication has been lost: your friend is now so far up that they cannot hear your pleas to reverse course.  It’s dangerous.  You know it, but your friend keeps climbing higher.

Central bankers caught in a dilemma

In this scenario, you know that if you were to tip the ladder over, your friend would be seriously hurt.  Conversely, you could do the ‘responsible thing’ and not tip the ladder over, but if you did that and your friend ended up falling from an even higher position, the consequences could be deadly.    Central bankers are caught in the horns of a dilemma. Continue Reading…

The Perfect Storm for Gold

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Image courtesy BMG Group

By Nick Barisheff

Special to the Financial Independence Hub

In December 1997, The Financial Times ran an article entitled “The Death of Gold.” Since then, the gold price in US dollars has increased 519% from $288 to $1,780. Today, after many political events and crises we have evidence of the continuous and in many ways spectacular growth of the gold price. This confluence of many current events is creating a perfect storm for gold to increase dramatically more than we imagined.

Currency Devaluation

Typically, currency devaluation is always at the heart of a rising gold price. This has been taking place in all of the major fiat currencies, resulting in an average annual price increase in gold of over 10% since 2000.

“For the naïve there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government’s Treasury Department.” — Ludwig von Mises

Since 1900, all major fiat currencies have been devalued by over 90%.

To understand currency devaluation, it is necessary to understand that all currency is created by governments issuing debt and then the central bank monetizing that debt by printing the currency. In 1960, the U.S. federal debt to GDP stood at 52.2%, whereas today it has grown to 125.9%. The Federal Reserve has increased its balance sheet by a historically unprecedented amount of over $7.5 trillion since 2008.

Because of this central bank policy, all western currencies are being devalued and this in turn leads to inflation.

“Nations are not ruined by one act of violence, but gradually and in an almost imperceptible manner by the depreciation of their circulating currency, through excessive quantity.”

— Nicholas Copernicus – 1525

 “Fed Chairman Powell has pumped trillions of newly printed dollars into the system in order to prop up the financial markets, but in the process has unleashed a tsunami of inflation that is unlike anything we have seen since the 1970s.” — Michael Snyder

“For the first time in history, ALL the major central banks are printing money. One of two things will occur. If they continue to print, their respective currencies will lose their purchasing power, and we’ll have inflation or even hyper-inflation.”

As Currencies are Devalued, Price Inflation will inevitably follow

Inflation, as this term was always used everywhere and especially in North America, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term ‘inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, and that is the tendency of all prices and wages to rise.

In October 2021, consumer inflation jumped to a four-decade high, the highest since the days of runaway inflation in the early 1980s. Headline year-to-year GDP inflation hit a 38-year-plus high of 4.53%.

According to John Williams of Shadowstats.com, if inflation was calculated using 1980s methodology, the CPI would be nearly 15%. Since treasury yields are about 2%, the true inflation-adjusted treasury yield would be about -13%.

Gold Rises Fastest When Real Yields Go Negative

 

Inflation is destined to go even higher in 2022. Many of the biggest corporations have already announced price increases that will take effect in 2022.

Declining GDP — Stagflation

“The…economy is facing a period of stagflation in which both growth and inflation disappoint.” — David Walton, Goldman Sachs

Stagflation is worse than a recession. It’s because stagflation combines the bad economic effects of a recession (stock declines, unemployment increases, housing market dips) with inflated prices. When this is dragged out over the long term, it becomes a problem that can have a big impact on societal habits.

To make matters worse, we are already experiencing declining GDP together with increasing inflation. This is due to an unusual combination of supply chain disruptions and labour shortages due to COVID-19 policies that have been implemented in most western countries.

Supply Chain Disruptions

The COVID-19 pandemic impact and the disruptive government responses continue to have enormous negative impact on global supply chains. Beyond COVID-19, compounding profound governance incompetence, media bias, political conflicts, disintegration of society split by “Covid politics,” natural disasters, cybersecurity breaches, international trade disputes have negatively impacted supply chains leading to product shortages, distribution delays, and manufacturing disruptions. The lockdowns imposed in many countries have led to revenue declines and many bankruptcies, with many more to come. Making matters even worse is the implementation of vaccine mandates, causing over 4 million people to leave the workforce in the U.S. This will lead to other societal problems due to lack of first responders, nurses, firefighters, and police.

Some analysts expect that it will take years for the capacity constraints and backlogs to ease. Continue Reading…

Vanguard 2022 Outlook projects lower 10-year returns for 60/40 portfolios

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Vanguard Global Economist Joe Davis: Vanguard.com

Returns on the traditional 60% stocks/40% bonds balanced portfolio are expected to be roughly half of what investors realized over the last decade, according to the Vanguard Group’s 2022 Economic and Market Outlook, which is being released today (Monday, Dec. 13).

Global stocks are expected to outperform U.S. stocks bonds significantly over the next ten years while US and global bonds will be in the range of 1.3% to 2.4% annualized ,

Here are Vanguard’s 10-year annualized return projections:

  • Global equities: 5.2% – 7.2%
  • U.S. equities: 2.3% – 4.3%
  • Global bonds: 1.3% – 2.3%
  • U.S. bonds: 1.4%– 2.4%

The report issued by Valley Forge, PA-based Vanguard is titled Striking a better balance: ironic given its projections for performance of balanced portfolios.

“The road ahead for investors promises to be a challenging one,” said Joe Davis, Vanguard’s global chief economist and co-author of the report. “Global markets will test investors’ discipline as they navigate the risks of unwinding monetary policy support, slower growth, and rising real rates.”

In an advance webinar aired last Thursday, Davis said: “Wage inflation will dictates the pace of rate hikes in 2022.” He said the US Federal reserve is likely to raise rates to at least 2.5% this cycle in order to maintain price stability. As for stocks, we are in an era of “high valuations and low rates,” which creates a “fragile backdrop for markets ….[which] will chip away at future returns.” Better valuations are in developed markets outside the US, small-caps and Value. More stretched valuations are in Emerging Markets, the US, Growth and Large-cap, Davis said.

US equities have not been this overvalued since the dot-com bubble, Davis said, adding that a secular decline in rates has been three decades in the marking.

For Bond markets, best values is in TIPS and short-term treasuries. Most stretched are long-term treasuries, mortgage backed securities and international credit. In between are intermediate treasures and high-yield bonds.

Policy accommodations

In Monday’s press release, Vanguard said challenges are likely to be most evident with the unwind of monetary policy, a critical factor in 2022 as central bankers assess a rapidly evolving economic landscape. Inflationary pressures have sharpened the focus on monetary policymakers as these pressures may drive changes in central bank communications and actions. Vanguard projects that central banks will largely try to avoid sharp and unexpected shifts in the timing of policy changes, particularly of policy rate increases, but that conditions will force them to act in 2022 and quite possibly by more than markets are anticipating.

Economic outlook

With the global economic recovery expected to continue in 2022, Vanguard economists foresee the low-hanging fruit of rebounding activity to give way to slower growth, regardless of supply- chain dynamics. In both the U.S. and the Euro area, Vanguard expects economic growth to normalize to 4%. In the U.K., Vanguard expects growth of about 5.5%, and in China, expectations are that growth will fall to about 5%.

Inflation

Vanguard expects labor markets will continue to tighten, with several major economies quickly approaching full employment. Vanguard estimates the cyclical effects of supply constraints will persist well into early 2022 and then normalize as the structural deflationary forces of technology and unemployment take hold again. These factors contribute to expectations that inflation will trend higher for some time before slowing in the second half of 2022.

Don’t fear a “lost decade” for US stocks but a lower-return one

Vanguard’s long-term outlook for global asset returns for 2022 and beyond remains guarded, particularly for equities where valuations are high and low real interest rates continue to act as a strong gravitational pull on future returns. Investors should not fear a “lost decade” for U.S. stocks, but rather, a lower-return one, it says. For fixed income, low interest rates mean investors should expect lower returns. However, because rates have risen modestly since 2020, Vanguard’s outlook is commensurately higher.

International equities will outperform US in coming decades

Given the differences in valuations between the U.S. and non-U.S. developed markets, Vanguard projects international equities will outperform U.S. equities in the coming decades and value stocks will outperform growth in the U.S.

It says investors are best served in a broadly-diversified portfolio, including international equities.

“While the economic recovery is expected to continue through 2022, easy gains in growth from rebounding activity are behind us, and policy will replace health as the leading consideration for investors,” Davis said, “Despite a potential low-return environment, we are still expecting a positive premium for bearing equity risk. Investors should continue to focus on what they can control, and if they have the patience to weather potential periods of underperformance, we believe accepting some active risk offers the opportunity to offset low future returns.”

Inflation: Transitory with a Twist

At the advance webinar, Vanguard America’s Senior Economist Roger Aliaga-Diaz projects inflation to be “Transitory with a Twist.” He foresees only a modest decline in inflation in 2022. Central banks, including the Fed, will have to normalize sooner than later. “We may see next week [i.e. this week: Dec. 13 to Dec 17] accelerating tapering but not likely to hike rates.” He expects “one or two” hikes in the second half of 2022. Inflation will be around 5% early in 2022 but this should be in the low 3s by the end of 2022. Continue Reading…