• Given that the U.S. Federal Reserve is expected to raise rates in response to inflation as early as the end of 2022, the natural question is whether low-volatility strategies will disappoint in such an environment.
  • Interestingly, nominal interest rates (meaning they don’t account for inflation) haven’t historically mattered so much as a predictor of future returns for low-volatility securities.

A combination of strong demand and global supply bottlenecks caused consumer prices to surge by 5.3% over the 12-month period ending July 2021, the fastest year-over-year pace in 13 years.1 Given that the U.S. Federal Reserve (Fed) has historically sought to manage inflation by governing interest rates—typically raising rates to slow the economy when inflation exceeds a target level—the timing of the Fed’s next interest-rate hike has come into sharper focus for many investors. 

While the Fed has some ability to influence inflation, it can’t as easily control expectations for future inflation—a market-based measure referred to as the breakeven rate. The breakeven rate represents the difference between the nominal yield on U.S. Treasurys of a given maturity (interest payment before adjusting for inflation) and the yield on an inflation-linked bond (which inherently rises and falls with the rate of inflation) with the same maturity. 

If the Fed were to start raising rates, a move it has indicated could come as early as the end of 2022, investors would view the move as a preemptive action to halt further inflation. Expectations for future inflation—the breakeven rate—show exactly this.

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1. Source: U.S. Bureau of Labor Statistics

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