A 10-year TIPS is yielding 0.34% (plus inflation) today on the secondary market, a drop of 27 basis points since the last auction Sept. 18, which resulted in a yield of 0.61%.
That’s a pretty big turnaround for TIPS. The chart below shows three months of price changes for the TIP ETF, which hold a broad range of maturities, versus the SPY ETF, which hold the S&P 500 stocks. The turnaround began on Sept. 18 – the very day of the 10-year TIPS reopening – when the yield reached its highest point in five months. That is also the day that the S&P 500 hit its three-month high.
The TIP ETF is down slightly today, trading at $113.51 at mid-afternoon, on a day that the stock market is faring very badly. The S%P 500 is down about 1.7%.
So TIPS are benefiting from a flight to safety, but not as much as might be expected. The reason? The market is pricing in very low future inflation, and that is putting a cap on demand for TIPS.
At yesterday’s close, a traditional 10-year Treasury was yielding 2.35%, according the US Treasury daily estimate. A 10-year TIPS was yielding 0.39%, creating a 10-year inflation breakeven rate of 1.96%. So a 10-year TIPS will outperform a 10-year Treasury if inflation runs higher than 1.96% over the next 10 years. That is a low breakeven rate, and it indicates demand for TIPS hasn’t really increased much as the stock market has declined.
Here is a chart of 10-year breakeven rates since January 2012, and it demonstrates the very steep and very fast decline in inflation expectations:
My general feeling is that TIPS are attractive – at least versus traditional Treasurys – when the breakeven rate drops below 2%, as it has now. But yields have also dropped in recent weeks, making TIPS a little less attractive overall.
Treasury Inflation-Protected Securities 
YM, I readily admit it is a behavioral investing strategy, but it is in line with reality. This TIPS will mature on this date at this price (plus inflation). It is a sure thing. As for investment expenses, mine are zero since I buy at auction directly from the Treasury. But I should point out that my asset allocation in the total bond market (Vanguard) is about three times larger than my holdings in TIPS and I Bonds. So it isn’t that I don’t like bond funds, or avoid them. It’s just not the way I prefer to buy inflation-protected investments.
“I disagree, and so would many financial experts. However, many would agree with you. There is no right answer, so it comes down to how you view the investments. The question in a buy-and-hold strategy is: Are you going to track your bonds at ‘market’ prices, and thus see all the ups and downs, or are you going to hold them to maturity, and only view their par value (in the case of TIPS, adding in the inflation appreciation). That is how I track my holdings. I don’t care what the secondary market value is, and the price does not fluctuate from day to day. The problem with this strategy is exactly what is happening now: TIPS with attractive yields mature and less-attractive TIPS are added to the portfolio (or not, it’s the investor’s choice.)”
–So, you have explicitly adopted a behavioral investing strategy w/r/t TIPS which is fine as long as you realize that’s what it is. Also as long as you realize that even if you don’t care what the secondary market value of your individual bonds are, that’s an objective reality that you’re choosing to ignore (which is what makes it a behavioral investing issue). The point is that financially, there’s no difference between a bond fund and a collection of individual bonds, whether that’s a ladder or some other individual grouping, other than the strategy to maintain duration/maturity with the bond fund, and not to do so with with a group of individual bonds (but you do in effect maintain average maturity and duration with a rolling bond ladder anyway).
Since the market for government bonds is very efficient, it’s hard to see why an individual retail investor would ever think they could beat or outsmart that market, i.e. beat or outsmart a professional bond fund manager or a bond index fund. You’re not going to get lower spreads and you’re not going to get lower commission than a bond fund. You will have to pay the expense ratio with the bond fund. On the other hand, the bond fund manager knows better than the average retail investor how to ride the yield curve down in its buying and selling transactions, probably has less reinvestment risk, etc.
Let’s think about it a bit: Does it really even matter if the CPI number generated by the government based on recent economic statistical measurements, and used for TIPS inflation adjustment, is “accurate”? I don’t think so. I think the breakeven rate is telling us what the market thinks inflation is going to be going forward (less the “insurance premium” for unexpected inflation component in TIPS). The CPI adjustments to the TIPS by the government are backward-looking; the breakeven rate set by the aggregate of all market participants is forward-looking. So TIPS aren’t being priced by the market based on what government says the CPI change has been. Of course, government CPI measurements are an important data point for the market, but that’s all they are. To the extent the market for TIPS vs. nominals comes to believe in the aggregate that government CPI measurements are a hoax or simply that they are inaccurate as a measure of inflation, then those inaccuracies will be discounted into the price for TIPS that the market demands (relative to nominals and all other available investable financial assets).
So, the low breakeven rate is telling us that the MARKET for financial assets, in the aggregate, believes future inflation will be low. Now depending on unanticipated future events that “prediction” could turn out to be wrong. But right now it’s the market’s “best guess.”
I don’t think that the CPI figures are a hoax. They will never match any one personal inflation rate. However, in the aggregate, it’s probably about as close as you’re going to get. It’s human nature to focus on purchases that are going-up – and, minimize what’s going down.
For example, gas prices are tanking right now (right after I bought a hybrid vehicle, of course). The energy sector makes-up a good chunk of the overall inflation rate. As a result of this inflation went down from an annualized rate of 2.1% to 1.7%. Gas prices have DEFLATED 10% in two months.
That hybrid car that I bought has actually been coming-down in price over the last few years. Due to the recession, I was able to purchase it for about the original purchase price for the 15 year old car that it replaced (non-hybrid). You don’t see that everyday, but that’s DEFLATION in my book.
By refinancing the mortgage on my house a while back, the monthly payment was cut by around a third. I made-up for the fees paid in the first month of the new loan. That’s another example of DEFLATION that only shows up as “rent/rent equivalent” in the CPI-U.
Of course, all of this lovely deflation when purchasing things comes at a price when saving money. Back in the good old days, you could actually beat inflation by just buying a CD with a term of a year or more. And, TIPS actually had a coupon that would provide a yield to maturity over 1%.
Unfortunately, I’ve only been dabbling in the TIPS market for a little over a year now. So, I haven’t been able to purchase anything with a YTM over 1%. This kind of leaves me wondering if I’m being a sucker for buying them at a time when the FED is supposed to be raising interest rates.
Any way you cut it, TIPS are not superstars. But, it was never designed to be that. It’s the only investment out there that guarantees the preservation of purchasing power (assuming you accept the premise that the CPI-U is valid).
From reading what’s available on this site and others, I’ve learned the vagaries of investing in TIPS. First and foremost, that preservation of purchasing power only applies to buying the actual bonds with a positive YTM and holding them to maturity. Not TIPS funds.
Since this meets the minimal goals for a small portion of my retirement fund, I’m willing to put up with the paltry YTM. Until the coupons on TIPS recover to pre-recessionary levels, anything more than a small portion seems foolhardy. Particularly, at this point in time (rising interest rates).
The last month in the TIPS market has been maddening. Back on September 22nd, I purchased some TIPS maturing on 4/15/2015 on the secondary market. The YTM was just barely over 0% (0.10% to be exact). Today, that same TIPS has a YTM of -0.124%.
I keep wanting to buy more TIPS this year, but the ones that I’ve actually bought are begging for me to sell them and take a profit. One from January has gone-up 4.84% (annualized, 6.98%). That’s the equivalent gain of keeping the TIPS for 2.8 years at the current inflation rate of 1.71%.
Yup, I could do nothing with the money cashed in for almost 3 years before I would entertain a loss on the trade. Since I’m a buy and hold sort of guy, I’m finding this year extremely annoying. I don’t have a trader mentality. But, maybe I’d be a fool not to take the money and run!
Transactions costs aside, which can be minimized, there is for the average retail investor effectively NO DIFFERENCE between a collection of individual “bonds” and a “bond fund” other than the bond ladder/collection of individual bonds has a constantly declining duration and maturity (unless you keep rolling matured bonds into new bonds to extend the ladder). If you want your bond fund(s) to have a constantly declining maturity/duration, that is very very simple to do nowadays at very very low cost simply by mixing in the desired proportion of short/intermediate/long term bonds.
It is a logical and financial fallacy to believe that holding a collection of individual bonds is any less or more risky than holding a bond fund.
I disagree, and so would many financial experts. However, many would agree with you. There is no right answer, so it comes down to how you view the investments. The question in a buy-and-hold strategy is: Are you going to track your bonds at ‘market’ prices, and thus see all the ups and downs, or are you going to hold them to maturity, and only view their par value (in the case of TIPS, adding in the inflation appreciation). That is how I track my holdings. I don’t care what the secondary market value is, and the price does not fluctuate from day to day. The problem with this strategy is exactly what is happening now: TIPS with attractive yields mature and less-attractive TIPS are added to the portfolio (or not, it’s the investor’s choice.)
Not too far off the topic… When are TIPS attractive? Well let me share a little personal research- which everyone should do. In the last year my car insurance has gone up 4% (same car, a year older). My health insurance has gone up 12% and the utility company is lobbying for a 5% increase (which they’ll get). Just a checkup at the dentist went up 8%. And what was the CPI for the last year, under 2%? The famous bond investor Bill Gross has said for years that the government CPI figures are a hoax and I’m thinking he’s right. So laddering TIPS thinking you’re maintaining purchasing power may be just an illusion. (From a medium size Midwestern city.)
Len, I agree that my personal rate of inflation sure seems a lot higher than 2%. TIPS are tied to CPI-U and that is the rate that will determine your returns. The costs of some things, such as cars and computers and even rents, have been fairly stable in the last decade, but we don’t buy a lot of cars or computers or pay rent. We buy food, go to the dentist, pay for cable TV, buy home insurance, pay property taxes. The costs of those items seem to be rising much faster than ‘overall’ inflation. TIPS are just insurance against runaway inflation, which has happened in our lifetimes and certainly could happen again. Meanwhile, nominal Treasurys pay practically nothing, so there are no great safe options.
Do you not feel that in an environment of low inflation, it is more attractive to stay nominal? Currently I am 100% invested in the total bond index fund and 0% in the TIP etf. I think that I will stay like that until better TIP real interests.
Erwin, I also prefer the Total Bond Market as my main bond fund holding. It is a lot less volatile and holds a much more diversified portfolio. I have very small holdings in a couple of TIPS funds, mainly to get their annual reports. I prefer to buy TIPS at auction and hold them to maturity, which incurs zero costs and assures me of a 100% return on my principal, or more.
Thank you for your reply. I do understand your strategy and frankly I am also contemplating something similar. I have plans to purchase a 10 year ladder to cover my retirement expenses from 70 to 80 (I am now 66). However, I am hoping that real rates will go up once the Fed begins raising rates and then I can get a better deal. Does that make sense to you?