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A strong US economy and falling unemployment suggest that inflation could be around the corner. We think that inflation-linked US bonds, like treasury inflation-protected securities, provide a good hedge against rising inflation.

As the US economy continues to strengthen and unemployment declines, we expect inflation pressures to rise. We’ve already started to see a sustained rise in CPI both in the US and here in the UK as unemployment falls.

TIPs now in Nutmeg portfolios

To hedge against the risk of rising inflation, we’ve added inflation-linked US bonds – known as treasury inflation-protected securities (TIPS) – to our portfolios. TIPS can also offer diversification within a portfolio due to their low correlation to some other investments, including UK government bonds.

How would rising inflation affect US government bonds?

We expect that inflation will negatively affect the prices of regular US government bonds – that is, bonds that aren’t inflation-protected. Why? As inflation rises, not only do the low current bond yields become less attractive, but the Federal Reserve will also come under increasing pressure to increase interest rates, in order to curtail inflation. This pushes bond prices down.

Conversely, we expect that inflation-protected securities will be better-protected relative to our existing US bond exposure.

CPI vs US unemployment, 2008-2016

Limiting currency risk

As well as hedging against inflation, we’ve also chosen to hedge the currency risk of these bonds, too.

So investors with a sterling-based portfolio will have their exposure limited to the return from the TIPS themselves, and won’t be impacted by swings between the two currencies.

Risk warning

As with all investing, your capital is at risk. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek independent financial advice. Past performance is not a reliable indicator of future performance.