Over the last couple of years, Treasury Inflation-Protected Securities were the toughest prizefighter in the investment world: You could knock them around a little, but they always came roaring back.
Then … Ben Bernanke spoke.
It was May 22, and the Federal Reserve chairman was speaking to the Congress’ Joint Economic Committee. Although the Fed chairman said a lot of middle-of-the-road mumblings about economic stimulus, jobs and interest rates, the markets seized on this comment about the Fed’s monthly purchases of $45 billion of Treasuries and $40 billion of mortgage bonds:
“At its most recent meeting, the Committee made clear that it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.”
Later, in response to a question, Bernanke suggested – but only suggested – that the bond buying could be trimmed back in the next few months, if the economy continues improving.
Even before May 22, yields on TIPS had been rising, because of recent reports showing very weak inflation – running just 1.1% over the last 12 months. Now, with the suggestion that Federal bond-buying might slow down or even halt, the trend was locked. Here’s what has happened in those 23 days:
| Yield | 22-May | 13-Jun | Basis points |
| 5-year Treasury | 0.91% | 1.11% | 20 |
| 5-year TIPS | -1.06% | -0.69% | 37 |
| 10-year Treasury | 2.03% | 2.19% | 16 |
| 10-year TIPS | -0.24% | 0.15% | 39 |
| 30-year Treasury | 3.21% | 3.33% | 12 |
| 30-year TIPS | 0.83% | 1.17% | 34 |
| TIP ETF | $117.77 | $114.57 | -2.8% |
What’s interesting here? Yields on TIPS are rising much faster than the overall bond market, hitting 2-year highs. Yields on nominal Treasuries, however, are increasing at a slower pace and really haven’t hit unusual levels. For example, on March 19, 2012, the 10-year Treasury hit 2.39%, 20 basis points higher than the current level. On that same day, a 10-year TIPS was yielding -0.03%, 18 basis points lower than today’s level. That’s a 38 basis-point swing.
And so … the ugly truth. TIPS are being battered because investors have lost their lust for this one particular product. That’s a hard trend to reverse. And when overall interest rates do begin climbing, TIPS will be battered even more. When you see a 10-year Treasury at 2.75%, you can expect to see a 10-year TIPS yielding around 0.6%.
For TIPS traders and mutual fund holders, if overall rates really do rise, that’s going to mean more bad news, possibly a decline of another 5%, especially if inflation remains muted.
The bright spot. This trend also means that TIPS are getting cheaper against nominal Treasurys, and more attractive to the buy-and-hold investor. If you are a buying small amounts with each auction, the outlook is good. Higher yields are a good thing.
Treasury Inflation-Protected Securities 
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Jim, I definitely endorse reinvesting your interest, especially now that the TIP ETF has fallen more than 7% from its high. Back in June 2011, before Fed bond-buying began in earnest, the TIP was priced at $111, about 3% lower than it is today. That to me looks like the short- to medium- term downside risk. But the 10-year TIPS was yielding 0.74%, much higher than it is today, so maybe there’s more risk in the longer term. Rising rates could hit the overall bond market for years, and this process could just be starting. But I am not pulling out of the bond fund allocation in my portfolio. (In other words, I have no idea and I’m just guessing at the future.)
I own TIPS Through Barclay’s ETF. I have automatically been re-investing interest income back into the ETF with each payment. If the price continues to decline this effectively dollar cost averages a lower cost basis. Is this a wise strategy or will I be trapped in a rising rate environment of unknown duration?