US investors are back in the hunt for inflation protection for the first time in two years as rising housing costs – particularly for rent – suggest inflation may finally be waking from its post-recession slumber.

That is helping to drive cash into speciality funds that focus on Treasury Inflation Protected Securities, or TIPS, arguably the weakest corner of the US government bond market over the previous year or so, and helping TIPS significantly outperform regular Treasuries this year.

TIPS-focused funds are on pace to end seven consecutive quarters of outflows over which investors drained almost $38 billion from the sector.

They have attracted $1.52 billion so far in the third period, marking the first quarterly inflows since the third quarter of 2012 and the largest since the first quarter of 2012.

Fund managers said the rising cost of housing – which accounts for as much as a third or more of various measures of inflation and is outpacing other consumer cost increases – has revived price pressure in the economy.

“TIPS have had a good tail wind this year. We have inflation as opposed to last year when we had disinflation,” said Gemma Wright-Casparius, who oversees Vanguard’s $26.3 billion inflation-protected securities fund, the biggest US fund of its kind. The fund is up 6.5 per cent this year.

Wright-Casparius also helps manage a short-dated TIPS fund whose assets have reached almost $10 billion since it launched nearly two years ago.

Inflation will likely creep higher in the coming months, according to a Reuters poll of economists. The Consumer Price Index has risen at 2 per cent year-over-year for four straight months now and is forecast to accelerate to 2.2 per cent later this year and into 2015, the data shows.

This outlook along with the possibility the Federal Reserve will raise interest rates in 2015 make TIPS a sensible choice, bond managers said. Also, the fact that Fed chair Janet Yellen has signalled a willingness to let inflation run a bit hot relative to the central bank’s target is also a positive, because the principal of a TIPS bond increases with inflation.

US inflation bonds have produced a return of 6.35 per cent since January, about 3 percentage points more than regular Treasuries, according to indexes compiled by Barclays.

In 2013, TIPS suffered their worst year since they were introduced in 1997, posting an annual loss of 8.61 per cent compared with a decline of 2.63 per cent for the broader Treasury market.

To be sure, it may be difficult for TIPS to sustain their recent gains.

“I think it’s going to be much more challenging for them to generate returns as high as they have been in the past year or year to date,” said Bill Irving, a Merrimack, New Hampshire, portfolio manager for Fidelity Investments, which manages $2 trillion.

That is because a sizeable portion of their gains this year are the result of an unexpected collapse in “real yields,” or yields as measured against inflation. This proxy on the market’s view on economic growth came after a stunning 2.9 per cent drop in gross domestic product in the first three month of the year followed by a second-quarter 4.2 per cent pop.

The real yield on 10-year TIPS, which move inversely with their price, tumbled from 80 basis points early in the year to 20 basis points recently. Shorter-dated real yields are actually negative, with inflation outstripping nominal yields.

A dramatic rally in bond markets worldwide, dragging US yields back to their lowest levels in more than a year and yields on some European sovereign bonds to their lowest ever, further supported TIPS’ revival.

A variety of factors behind the rally include demand for low-risk sovereign bonds in face of conflicts in Ukraine and the Middle East and negative yields across the Atlantic where European Central Bank is expected soon to embark on new steps to avert Japanese-style deflation.

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