The Federal Open Market Committee concluded 2024 with its third consecutive cut to the overnight borrowing rate. Chair Jerome Powell indicated that the pace of rate cuts is expected to slow in the coming year. Recently, the Fed lowered rates multiple times, driven by strong economic growth and easing inflation. However, uncertainty looms over how these factors will evolve into the new year.
Stubborn Inflation and Economic Policy Concerns
Inflation remains persistently above the Fed’s 2% target, leading to an increase in its 2024 core inflation forecast to 2.8%. The incoming Trump administration’s proposed policies, including tariffs and mass deportations, may further inflame inflationary pressures.
Investment Strategies for 2025
Navigating this financial landscape can be complex for investors aiming to adjust their portfolios as the new year begins. For a more cautious approach, consider investments that hedge against inflation. Fortunately, several exchange-traded funds (ETFs) are available that suit this inflationary environment. These funds are accessible and require minimal management from investors while providing diverse asset class exposure.
Diversify with Broad TIPS Exposure
Treasury Inflation-Protected Securities (TIPS) are appealing bonds indexed to inflation, making them popular among cautious investors. While purchasing TIPS directly is an option, the iShares TIPS Bond ETF (NYSEARCA: TIP) offers easier access. This fund grants exposure to a wide range of TIPS with various terms for a low fee of just 0.19%.
Although TIP is considered low-risk, thanks to being backed by the U.S. government, it also typically offers modest returns. It’s a preferred choice for many investors due to its large asset base and consistent liquidity among TIPS-focused ETFs. Remember, though, that while TIP provides some inflation protection, it’s not a guaranteed safeguard. Monitoring interest rates is advised while investing in this fund.
Oil as a Hedge Against Inflation
Commodities have historically served as strong inflation hedges. Research from Goldman Sachs shows that a 1% unexpected rise in U.S. inflation often leads to a 7% increase in real returns for commodities as a whole.
Among commodities, oil stands out as a solid protective measure against inflation, as energy products tend to react to both supply and demand fluctuations—unlike some other commodities that may respond better to only one of these factors.
The United States Oil Fund (NYSEARCA: USO) strikes a balance between value and liquidity among oil ETFs. Its expense ratio is 0.60%, and it manages $1.1 billion in assets as of December 26, 2024. While it’s neither the largest nor the most liquid oil ETF—which is the United States Natural Gas Fund (NYSEARCA: UNG)—it remains more affordable than competitors, including UNG.
Investors should be cautious, however, as volatility in oil prices can lead to challenges such as contango, which might affect long-term holders of this fund.
Exploring the CLO Investment Opportunity
Collateralized loan obligations (CLOs) are securities that bundle high-risk debts, including leveraged loans to companies with potential default risks. These securities can be appealing for inflation-conscious investors due to their floating rate yields. However, they bear a higher risk that many investors may want to avoid.
The Invesco Senior Loan ETF (NYSEARCA: BKLN) offers an effective entry into the CLO market through ETFs. By providing a wide portfolio of loans, BKLN can help mitigate default risk. Still, this ETF may not be suitable for those unfamiliar with the high-risk nature of this investment space.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
