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Inflation and Preferred Outcomes

Destra Capital

July 12, 2021

Inflation has been the talk of the town lately. With increased vaccination rates in the US and the resulting reduction in Covid cases, the US economy has shown signs of a strong reopening move to start the year.

With it has come concern about inflation and that concern was amplified recently with an eye popping 5.0% CPI report in May.

Investors’ interest in inflation and its potential impact have spiked since that May CPI report.

Bloomberg News Trends Story Count for "Inflation"

Number of Stories per Month

Source: Bloomberg


These concerns are founded in the memory of hyper-inflation in the ‘70’s and the resulting historically high interest rates that Paul Volker used to break the back of inflation and bring interest rates back to “normal”.

50 Years of US Inflation vs Interest Rates

US Monthly Inflation (year-on-year % change) vs Fed Funds Interest Rate

Source: FRED, Federal Reserve Bank of St.Louis, US Bureau of Labor Statistics

But as the chart above shows, after the extremely tight correlation of inflation and interest rates between 1970 and the early 1980s, the two have not been in such “lock step” now for almost 40 years.

Still the basic concept of duration risk is that rising rates will make existing bonds less attractive, as new bonds will be issued with higher current coupon. And the idea that inflation can drive interest rates higher is one that the market has not forgotten.

When it comes to rising rates, whether from real or imagined inflation, history tells us that Preferred Securities have done much better than investors may have thought.

Perhaps the time is right to reconsider adding Preferreds to a portfolio, no matter which way inflation is going!

Source: Treasury.gov, Morningstar, Barclays and Bloomberg

Table surveys daily data. Indexes are unmanaged, do not reflect the deduction of fees or expenses and are not available for direct investment. Past performance is not indicative of future results. Index performance is for illustrative purposes only

1 The Preferred Benchmark consists of the ICE BofAML Fixed Rate Preferred Securities Index (P0P1) for time periods prior to 3/31/2012, and thereafter the ICE BofAML 8% Constrained Core West Preferred & Jr Subordinated Securities Index (P8JC). The benchmarks from ICE Data Indices, LLC (“ICE Data”) are used with permission. ICE Data, its affiliates and their respective third party suppliers disclaim any and all warranties and representations, express and/or implied, including any warranties of merchantability or fitness for a particular purpose or use, including the indices, index data and any data included in, related to, or derived therefrom. Neither ICE Data, its affiliates nor their respective third party providers shall be subject to any damages or liability with respect to the adequacy, accuracy, timeliness or completeness of the indices or the index data or any component thereof, and the indices and index data and all components thereof are provided on an “as is” basis and your use is at your own risk. ICE Data, its affiliates and their respective third party suppliers do not sponsor, endorse, or recommend Flaherty & Crumrine Incorporated, or any of its products or services.

2 Daily time series not available. Prior to 4/27/2000, only monthly returns are available on the Barclays Long US Corp Index