Over the past six months, and particularly in the last few weeks, we have seen inflation expectations rise materially. For example, the 5-year “breakeven rate,” a measure of inflation expectations based on the difference between TIPS yields and traditional Treasury note yields, rose by approximately half a percentage point to exceed 2%. As inflation expectations have risen, inflation-protected Treasury securities generally outperformed traditional Treasury securities of similar maturity that lack inflation protection. However, given the recent increase in inflation expectations, we now believe the potential for outperformance of TIPS is more limited in the near-term.
Federal Reserve monetary policy now seems the more likely driver of increased short-term interest rates in the period ahead. As such, we believed it was appropriate to shift a portion of the portfolio’s short-term TIPS exposure into investment-grade floating-rate securities. Floating-rate securities can benefit from rising yields as short-term interest rates increase, regardless of whether those increases are driven by inflation or other factors. This shift also marginally reduced the overall duration of the fixed income allocation, which is consistent with our continued expectation that interest rates will rise going forward.
Additionally, recent outperformance of global equities versus U.S. fixed income, the portfolio’s U.S. equity holdings versus international equity holdings, and certain U.S. equity sectors such as Information Technology and Financials Services, caused Global Balanced portfolio weights to drift away from our target allocations. We decided to rebalance the portfolio to bring weights back in line with the target allocations based on our current outlook.