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:
The 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.