After about six weeks of turmoil in the markets for Treasury Inflation-Protected Securities, we have seen yields on TIPS rise dramatically and a resulting free-fall in market prices on TIPS and and TIPS mutual funds. A recap:
- The 5-year TIPS is trading today with a yield of -0.24%. On May 1 it was -1.50%. That’s a gain of 126 basis points.
- The 10-year TIPS is trading today with a yield of 0.59%. Yes, that is positive 0.59%. On May 1 it was -0.66%. That’s a gain of 125 basis points.
- The 30-year TIPS is trading today with a yield of 1.45%. On May 1 it was 0.440%. That’s a gain of 101 basis points.
- The TIP ETF is trading today at $110.44. On May 1 it was $121.50. That’s a decline of 9.2%. Since this fund has a duration of about 8, that is what you get when interest rates rise 125 basis points.
- Because the 10-year Treasury is currently trading at 2.52%, this creates a 10-year inflation breakeven point of 1.93% for a 10-year TIPS. My ‘cheap’ marker for TIPS is a breakeven point of 2%. We are there.
- Likewise, the breakeven rate for a 5-year TIPS is a very attractive 1.66%.
What this means. In less than two months, TIPS have gone from extremely expensive with paltry yields to reasonably priced with more acceptable yields. In other words, TIPS are again an attractive investment.
Strategy? I have said for two years that I am not a fan of TIPS mutual funds, which is the way most people hold TIPS in retirement accounts. Today, I am changing my view. My view is that it’s time dip gently into TIPS mutual funds and set up automatic investments for the future. In other words, dollar-cost average in.
The overall bond market has taken a shock in mid-2013, and it could very well over-correct. On the other hand, I can’t see interest rates really soaring until the economy drastically improves. And Fed is continuing is bond purchases for the time being.
The risk? The TIP ETF is down 11.1% from its all-time high. If yields on TIPS rise another 100 basis points, which could happen in the longer (or even shorter) term, you’re going to see another 8% drop. By starting with a small investment and dollar-cost averaging in, you can minimize that risk.
My overall strategy is not changing however. My main holdings in TIPS will remain purchases at TreasuryDirect and holding to maturity, along with I Bonds. (My two-year ‘buying strike’ ended with last month’s 10-year auction.) If these current yields hold, future auctions are going to be a lot more attractive.
That’s what I am doing, but I can’t say it’s the best advice for everyone. Just something to think about.