Treasury Inflation-Protected Securities

• The Federal Reserve looks likely to begin cutting short-term rates in 2019, possibly as much as 75 basis points over the next year.
• Yields for money market funds and short-term Treasurys will track lower with those rate cuts.
• Inflation-protected investments could perform well in a time of falling rates and steady moderate inflation.

The “glorious” days of getting a 2% return on a very safe, very liquid investment are drawing to a close. Why? The Federal Reserve is on the brink of beginning a series of cuts to its Federal Funds rate, the nation’s key short-term interest rate.

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• Both headline and core inflation numbers fell short of consensus estimates.
• Gasoline prices fell 0.5% in May, following a 5.7% increase in April. Gas prices could be a deflationary force in coming months.
• May’s mild inflation report leaves the door wide open for the Federal Reserve to begin cuts in short-term interest rates.

This report looks like good news for the stock and bond markets, because it reinforces the Federal Reserve’s likely plan to begin lowering short-term interest rates, possibly twice in 2019. The first cut could come next week, or possibly in July.

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• FRNs, 2-year Treasury investments, have been in the news recently because their yields topped all Treasury investments with terms up to 10 years.
• FRNs are attractive during a time of rising interest rates, especially for cash you know you will be holding for two years.
• But during a period of declining rates – which could be coming – shorter-term investments give you more flexibility, with just a small yield penalty.

On May 31, a typical FRN was yielding about 2.4% while the 10-year Treasury yield had dropped to 2.14%. That means FRNs currently have about a 25 basis-point advantage over a 10-year Treasury. That’s a pretty remarkable example of yield inversion, because the FRN’s base interest rate matches the current 13-week Treasury.

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