By David Enna, Tipswatch.com
If you follow me on Twitter (yes, I still call it Twitter), you might have seen a very recent (June 5) post observing that real yields appeared to be heading back below 2.0%, breaking a two-month trend.
Meaningful shift? I was wrong. That was just two market days ago, but things reversed rather dramatically in reaction to the May jobs report released Friday morning. The report was much more positive than expected, raising concerns that the Federal Reserve will now put off any rate cuts until 2025. From the UPI report:
Hiring accelerated in May as employers added a robust 272,000 jobs … Economists had estimated that 185,000 jobs were added last month, according to a Bloomberg survey. Average hourly pay rose 14 cents to $34.91, pushing up the yearly increase to 4.1%.
“These data are in no way supportive of an imminent move by the Fed to lower rates,” economist Rubeela Farooqi of High Frequency Economics wrote in a note to clients.
This report hit the bond market hard, with the the total bond market (BND ETF) falling 0.80% in one day. The TIP ETF, which holds the full range of maturities of Treasury Inflation-Protected Securities, fared even worse, down 0.82%. The Treasury’s estimate of the 10-year real yield rose 13 basis points in one day, to close Friday at 2.13%.
It’s been a crazy year so far for real yields, as summarized in this chart:
A year ago, on June 8, 2023, the 10-year real yield stood at 1.53%, a whopping 60 basis points lower than today’s 2.13%. At that time, the Fed was still one month away from its final rate increase. On July 26, 2023, it raised its federal funds rate target to 5.25% to 5.50%, where it remains today.
The 10-year real yield reached its 2023 high on Oct. 25 at 2.53% before gradually sliding to 1.74% to begin 2024. The market still hasn’t matched that high in 2024. Could it? A week ago, I had my doubts, but the apparently robust U.S. economy opens the door to higher yields.
At the same time, inflation seems to be weakening. The Cleveland Fed’s Inflation Nowcasting site is predicting CPI inflation of just 0.08% for May and 0.14% for June. U.S. gas prices have fallen nearly 7% since early April. The U.S. dollar strengthened Friday in reaction to the jobs report, plus rate cuts this week by the both European and Canadian central banks. A stronger dollar tends to hold down inflation.
Weaker inflation could give the Fed the opening it needs to cut interest rates later this summer, but then the fall national election begins looming. The Fed seems comfortable with holding rates at these levels for many months.
What does this mean?
This week’s boost in real yields opens another buying opportunity for people looking to build a ladder of TIPS to hold to maturity. Real yields are again solidly above 2.0%, a historically attractive level. And they could go higher. Who knows?
Here is a year-to-date chart of the net asset value of the TIP ETF, which holds the full range of maturities.
This chart could be painful for investors looking for capital gains on their TIPS holdings. But for investors holding individual TIPS to maturity, market swings don’t matter. An investor in an individual TIPS today can earn 2.0%+ above inflation for the length of the term. Here is a look at assorted secondary-market offerings I found Saturday on Vanguard’s platform:
I set the search for maturities from 2029 to 2043 and there are a lot of interesting offerings — 19 in total –some with high coupons (and premium prices), some with low coupons (and discounted prices). All 19 have real yields above 2.0%.
Despite the yield swings, TIPS remain an attractive investment.
• Now is an ideal time to build a TIPS ladder
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• Upcoming schedule of TIPS auctions
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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.Please stay on topic and avoid political tirades.
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
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Where do you find the real yield when evaluating a TIPS? I am at Fidelity. They provide YTC and YTW (yield to call and worst, respectively). No mention of ‘real’ yield. Are you using YTW as real yield?
For a TIPS, yield to worst is equivalent to real yield. There is no call with TIPS.
The caption that “TIP ETF has had a total return of 0.05% year-to-date.” triggered me. The problem is that a lot of bond mutual funds have had returns well below returns of individual bonds for years now. For example, VBIRX with an effective maturity of 2.66-2.9 years is sporting a trailing return of 2.89%. Returns on almost any bond with a 3 year maturity, munis excepted, is at least 5%. Even munis are returning 4.5%
This suggests that most bond funds are way over-priced. I asked my broker, and he contacted the home office experts. There was no response. Then I wrote John Rekenthaler at Morningstar. Again, no response.
The best response I got was that bond fund managers invested heavily in cash. But even CDs have been yielding 5% for almost two years.
Since I have had no clue as to why bund funds are returning so much less than individual bonds, I am very leery of investing in any bond fund until its returns start to approach market returns. I mean, the TIPS fixed rates (yields to worst) for 3 year maturities are about 2.5%. And that doesn’t even include inflation!!
And VBIRX TTM yield is only 2.89%? Give me a break…something fishy.
OK, you can’t equate trailing 12-month yield with total return. The price of any bond fund (or any individual bond) goes up and down with market yields. So a fund could have a trailing yield of 2.89% and a negative total return over that time. Same with any individual bond, if you were looking at current market price.
The Vanguard Short-Term Bond Index Adm fund (VBIRX) has a trailing 12-month yield of 2.89%, as you note, but its 30-day SEC yield is 4.88%, which is aligned with yields of other shorter-term maturities. It has a one-year total return of 3.66%, but year-to-date for 2024 the total return is only 0.39%. Why would that be? Because nominal yields have been increasing in 2024. The one year Treasury has increased from 4.80% on Jan 2 to 5.16% today. The 2-year is up from 4.33% to 4.87%. Etc. When market yields rise, the value of the bond falls. This is true for individual bonds (until maturity) and also for bond funds.
You can’t equate the trailing yield of a bond fund with current market yields, because the bonds in the fund were purchased months or even years ago. The bond you could buy today has today’s market yield, which in this case is higher. With bond funds I generally look at total return, which reflects changes in asset value + any interest paid out.
Agreed, total return is what an investor should look at. By owning a fixed maturity bond, it’s easy. Even better, with a TIPS or Ibond, you know what the real (fixed) return will be at maturity. But with a bond fund, it’s impossible to get any handle on the return…it’s like peering into a sausage with unknown ingredients.
Looking at VBIRX’ returns, distributions are as follows:
2020 $0.19
2021 $0.15
2022 $0.14
2023 $0.24
2024 $0.32 (projected based on first 5 months)
2025 $0.40 (?)
2026 $0.50 (?)
If VBIRX’ price were to stay at $10, percentage returns on distributions would finally reach 5% in 2026–slightly above today’s current yield on 3 year treasuries and non-callable CDs!
Unfortunately the price won’t stay at $10 dollars. Much, if not most, of the return will depend on price changes, which are inherently unknowable. In fact, rising federal government borrowing could easily drive interest rates higher and bond fund prices down.
So, yes, total return is what an investor should look at, but that requires a LOT of assumptions and speculation. I’ll leave that to the equity share of the portfolio.
That said, if distribution returns reach the point where they really have no place to go but down, I might consider buying bond funds again. Meanwhile, buying individual bonds and keeping them to maturity, you know what your returns will be. And if today’s “high” interest rates do eventually drop, you can also sell them for a nice gain!
Like many here, I have a TIPs ladder, which in many ways is like a personalized bond fund. And since rates have increased since I created it, when I look at its value online, the value of the bonds have all gone down and my personalized bond fund is under water.
But that’s not a worry for me since I plan on holding each TIPs to maturity and I won’t have to worry about bond price volatility. That’s no different than what VBIRX does.
BTW, I’d be worried that your broker had to call his head office to learn that bonds go down in value when rates increase.
I do not generally buy on secondary market because I don’t understand the price vs the adjusted price. For example from your table, 91282ckl4 4/15/29 on fido this am, yield=2.2%, Price = 99.750 and adjusted price = 100.843. Vanguard does not show adjusted price. I am assuming that’s accrued interest or the inflation adjustment? If I pay over par and then the prices is adjusted, am I essentially buying interest and my additional principal back in x years? It’s all a little mind bending so anything you can do , or point to, would be helpful. Otherwise, I will take the simpler course of buying at auction. Thank you for your excellent articles.
When you are buying on the secondary market, especially for TIPS that have been around for several years, you are going to be buying additional principal over par. You might get that principal at a discount, or a premium. On the Vanguard platform, you have to start the ordering process to see the current inflation index and the actual dollar amount you will be paying (although you could estimate it). This article describes the process, which I admit is confusing: https://tipswatch.com/2023/02/05/tips-on-the-secondary-market-things-to-consider/
David, I’ve been thinking about a comment someone posted a few weeks ago about buying tips on the secondary market that have a very low yield and therefore a deep discount. The argument was, I think, deflation is not a concern and they get par at maturity for a decent return. Does this mean they would function kind of like a T-bill? Do you think this still offers inflation protection? Thanks, Karlos
I think in general the strategy of buying a TIPS with a very low coupon rate is to avoid reinvestment risk, not deflation risk. So the purchase is more like a zero-coupon bond. If you buy a TIPS with a high inflation index, you will have some deflation risk, because only par value is guaranteed to be returned at maturity. If the discount is deep enough, in some cases you can buy the additional principal at total cost less than par value, so that would remove the deflation risk. On the other hand, if you have owned any TIPS for a few years, the additional principal has deflation risk, to some extent. I am sure no TIPS in history has ever matured at a price below par value, but the total principal can decline, and often does for a month or two, and then begins rising again.
Interest rate prediction is always challenging.
I’m still amazed at the 1980s with 10 and 30y rates >10% in 1984 produced a landslide incumbent election (everyone happy? … answer: relatively, yes).
The mid-1980s lead off the 30+ year bond bull market. Plenty of instances in the 1980s/1990s when real rates were above 2% … hitting 5+% in early 1980s
(although TIPS did not exist, real rates are knowable in hindsight)
Source: https://en.macromicro.me/collections/51/us-treasury-bond/3361/real-interest-rate-yield
Conclusion: I’m still debating with myself on my allocation to 10-30 year TIPS. Yes, the real yield is very high relative to past 20 years but not relative to past 50 years when nominal bonds have hit 5+% real yield. Me thinks the US is underestimating the Insidiousness of spending/inflation due to recency-bias.
Inflation rates in the early 1980s were extremely high … 9.6% in 1980 and 7.1% in 1981 — which created a need for very high nominal rates. Even by 1989 inflation remained at 5.2%, then 4.7% in 1990, 4.7% in 1991. If we have continuous inflation like that today, expect interest rates to rise to very high levels. (Hope that doesn’t happen.)
There is an interesting article in the WSJ about accepting target inflation rate to be 4% instead of 2%, by some well respected economists. Of course, as the article says, consumers hate 4% inflation even if they may be able to live with it. Although, the Fed is not going to move the goal post from 2 to 4%, I believe, maybe somewhat wishfully, that we will see inflation print to be between 3-4%, way into 2025, or longer. I realize that this thinking is not in line with the short-term Inflation Nowcasting by the Cleveland Fed. Staying with US Treasury Bills and expecting real rates staying above 2% may be reasonable. But then, predicting rates is no better than Boston (Lexington suburb is where we live) weather forecast; as they say here, if you don’t like the weather, wait for 10 minutes…;)
Whatever worth it may be: In my taxable account, for the next 6-9 months, I am moving from 4 week US Treasury Bills to 3 month bills as a preferred way to maximize returns. My next move, yet to be decided on timing, will, most likely, be to move to 6 month Bills. Long-term, as interest cuts become real, yield curve will flatten. Post flatenning, the curve should normalize with, hopefully, term premium becoming positive and staying positive. That will be the time to consider US Treasury notes and bonds. As I have shared before, I am not a fan of bond funds of any kind and own none. On all the posts about I Bonds, I have been buying them for me & my wife for the last 15 years or so and love them for all the good reasons articulated in the posts….started buying TIPS after learning so much from this site.
Yes, I started buying TIPS after learning so much from this site as well.
I read that article this morning. I consider 4% inflation over a long term to be highly destructive, but I think the main point was that the Fed will probably have to settle for 2%+ inflation, instead of its target 2.0%. The measure it uses, PCE, tends to run lower anyway, so would a PCE of 2.3% be acceptable if that meant all-items inflation of 2.8%? I look at the Cleveland Fed’s numbers warily, because they tend to run *high*, so this low prediction is at least interesting.
You are most likely right about long-term 4% inflation being destructive and representing the worst case. For so many reasons, the days of wishing low inflation that we experienced for 2+ decades is also gone. The neutral rate will most likely settle around 3 percent. For us all, cash will enable us to get risk free reasonable income for a while.
I meant to say 3-4%, and not below 3%
Im buying into TLT for a capital gains pop.
TLT (iShares 20+ Year Treasury Bond ETF) is a standard holding for many Bogleheads, so hard to argue against it. But it is volatile and meant for investors with a long-term horizon. Total return of -31.24% in 2022 and -5.93% year to date in 2024. Those negative numbers may indicate it is time to buy, for the brave.
The time to buy bonds is when interest rates are high, if you buy when interest rates are low you on the wrong side of the market. I’ also got TLTW, which pays me to wait.