Here we go again: TIPS yields diving toward negative real returns

Yields on Treasury Inflation-Protected Securities are plummeting, making TIPS you own (and TIPS funds) more valuable, but making TIPS a far less attractive investment in the near term.

US Treasurys of all sorts are booming because of a strong dollar, a new program of quantitative easing bond-buying in Europe, and general weakness in the equity markets. This is a flight to safety. Consider:

  • A 10-year US Treasury is yielding about 1.68%.
  • A 10-year German bond is yielding 0.30%.
  • A 10-year French bond is yielding 0.55%.
  • A 10-year Spanish bond is yielding 1.40%.
  • A 10-year Italian bond is yielding 1.60%.

So, where is the money going to flow? To higher yield and a stronger currency. Since January 1, the yield on a 10-year TIPS has fallen 38 basis points, from an already-low 0.41% to 0.03% yesterday. The yield on a 5-year TIPS has fallen 44 basis points, from 0.31% to -0.13%.

And while in recent months TIPS were under-performing the overall bond market (making TIPS cheaper as a relative investment), they are now outperforming, as shown in this year-to-date chart:

compareThe TIP ETF, shown in blue, is now outperforming the intermediate Treasury ETF (IEI) and the overall bond market (AGG). This means that inflation breakeven rates are rising, making TIPS more expensive against nominal Treasurys.

Right now the 10-year inflation breakeven rate stands at 1.65%, up 8 basis points from the 1.57% on Jan. 8 when I wrote on this topic.

There’s a 30-year TIPS auction coming up Feb. 19. A 30-year TIPS is currently yielding 0.54%, down 22 basis points since Jan. 1. This low a yield on a 30-year TIPS carries a danger: If held in a taxable account, it could end up cash-flow negative until maturity. The reason? The coupon rate may not cover the current-year taxes owed on inflation adjustments to principal. That makes a 30-year TIPS – at this yield  – a lousy investment in a taxable account.

My thinking is that TIPS aren’t going to be a very attractive buy-and-hold investment in the first half of 2015 – joining a pack of other flawed investments at the moment, I Bonds and bank CDs among them.

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5 Responses to Here we go again: TIPS yields diving toward negative real returns

  1. Len says:

    Good analysis, as usual. The I bond certainly looks better than the 5 year TIPS at the moment, cash flow constraints aside. Being in a high income tax state, bank CDs are about as attractive as a case of the measles.

  2. Jimbo says:

    For retirement accounts, CD’s aren’t looking to bad now. Heck, I’ve got a liquid account that’s actually beating the last trailing 12 month CPI-U. One year CD’s at 1.15% aren’t worth the bother. There’s a “raise your rate” 2 year CD out there with a rate of 1.35% that’s starting to look tempting (isn’t that sad). With inflation the way it (hasn’t) been the last few months, I may go out even further in maturity than 2 years. A month ago, I thought that I would be buying a boatload of bonds at the next 5 year TIPS auction. A month ago, the 5 year TIPS actually had a positive yield to maturity plus an inflation adjusted price below par for a short period of time. I used practically every dime I had available to do swallow those up.

    I’ve got a few CD’s maturing this year. The original plan was to move this money into the TIPS ladder that I have for maturities ranging from 5 to 10 years. When I bought those 5 year TIPS, it looked like finally things were headed in the right direction. Now there’s absolutely nothing that has a positive YTM and an inflation adjusted price below par available. The Plan B was to purchase more iBonds this year. Since the ones that I already have are TIPS proxies for the 1 to 4 year maturities, I’ll need to decide what to do with them this year. However, with the recent deflationary trends and 0% coupons buying more seems like a genuine waste. Until there’s a good six month’s worth of inflation, iBonds are just dogs while they have a 0% coupon.

    The only other boogeyman on the horizon is the FED’s indication that it will be raising rates this year. I just saw an interesting interview with Bill Gross today. He feels that the FED is going to do a symbolic quarter point raise sometime during the course of the year. And, that’s it for the year. One crummy tick up. He also said that it might take four additional years for the FED to get to what he calls the “new normal” for Treasuries. That new normal is 2.0%! That’s about an increase of 0.5% per year. So, my Plan C is letting cash sit in liquid accounts. Plan D is “raise your rate” CD’s. When I went into major defense mode back in 2009 by purchasing 5 year CD’s, I never dreamed that when they matured the FED funds rate would still be at 0% and interest rates would be basically the same.

    Since I’m still working, it’s not that big a deal if I’m playing a zero-sum game with the financial assets that I have. The only real financial goal that I have is to preserve principle. That was the big attraction of TIPS and iBonds. But when I finally do retire, it would be nice if things got back to normal and be able to actually beat inflation with relatively short-term securities. If the ticker keeps working, I’ll be collecting Social Security around the same time that Bill Gross predicts the FED will finally normalize rates. So now, I’ve got to start looking into how to minimize the taxes on the income that I’ll have in retirement. TIPS and iBonds in taxable accounts do this well for state taxes. But, with the way things stand right now, I think it’s time to start looking at other options.

  3. tipswatch says:

    Jimbo, I also have three bank CDs maturing this year, after 5 years of paying 3%. Our credit union – through the entire 5-year term – has allowed us to add monthly contributions to one of the CDs, still earning 3%. Oh, I will be sorry to see those go. Not sure where we will reinvest.

  4. Bob Vogt says:

    Do you know of any instructions that describes how to use the Treasury Direct Tax information I obtained from their website to file a 2014 1040 Tax Return? I purchased IAAC4912828UX6 4-Year 8-Month TIPs on the Treasury Direct website and although they provide a Form 1099-OID it does not look like the IRS Form 1099-OID. It has 6 columns: Starting Date, Ending Date, Description (Box 7), Original Issue Discount on U.S. Treasury Obligations (Box 8) , Market Discount (Box 5), Acquisition Premium (Box 6).

    The Starting Date and Ending Date are specified as well as Box 7. The only other column specified is Box 8 which has a value of $134.48. I know this value needs to be listed in Schedule B , Part 1 Interest Income. However must I report the Starting Date, Ending Date, Description (Box 7) and if so where would they go?

  5. tipswatch says:

    Bob, I got a notice a week ago from Treasury Direct that my OID was ready for download (that was the FIRST TIME EVER Treasury told me that in an email.) However, when I went to Treasury Direct, the form wasn’t there. So predictable. And yes, the Treasury 1099 form is unlike any other you will ever see. It takes some … guessing. I would suspect you just need to report the Box 8 amount in Box 8 on on the IRS form.

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