Treasury Inflation-Protected Securities

By David Enna, Tipswatch.com

Any long-time reader of this site knows I try very hard to avoid political discussions and I discourage political rants in the comments section. This is a site about inflation protection and investing with a focus on safety.

Thursday night’s presidential debate was difficult to watch, no matter your political persuasion. Did we get actual policy discussions? No. The solvency of the Social Security system was raised by the moderators, but we got in essence, nothing of substance from the two debaters.

But I was interested to see a report Friday from Bloomberg that combined inflation and inflation protection into the debate analysis. This was the headline, and you can read the article free on Yahoo! Finance: “Barclays Says Buy Inflation Protection to Prepare for Trump Win.”

It is based on a research report from Barclays Plc. From the Bloomberg report:

With former president Donald Trump appearing more likely to unseat Joe Biden in the Nov. 5 election, the market should “be pricing in a considerable risk of higher-than-target inflation in the coming years, and this is from a starting point of our thinking they already offered structural value,” Barclays strategists Michael Pond and Jonathan Hill said in a note.

The simple trade, they wrote, is a wager that five-year Treasury inflation-protected securities, or TIPS, will outperform regular five-year Treasuries, leading to a wider yield spread between the two. That breakeven rate — representing the market-implied expectation for the average inflation rate of the consumer price index over the life of the securities — will widen to 2.5% from about 2.25% currently, Barclays projects.

The reasoning

The authors point to former President Trump’s proposed 10% tariffs on all imports, and likely even higher tariffs for imports from China. In addition, his plan for an aggressive effort to deport illegal immigrants could trigger labor shortages and wage inflation. He has also proposed across-the-board tax cuts, which would add to the U.S. deficit and potentially stimulate consumer spending.

(I)f the odds in the coming months continue to favor a second Trump term, “we would expect them to be embedded in the market via higher breakevens as the November elections approach,” Pond and Hill wrote.

A similar analysis was recently laid out in a letter published by 16 prominent economists, all Nobel Prize winners. They wrote, “The outcome of this election will have economic repercussions for years, and possibly decades, to come.” You can read that here.

You can read a detailed analysis of import tariffs imposed by Trump and continued by Biden in this report from TaxFoundation.org. From that report:

As of March 2024, the trade war tariffs have generated more than $233 billion of higher taxes collected for the US government from US consumers. Of that total, $89 billion, or about 38 percent, was collected during the Trump administration, while the remaining $144 billion, or about 62 percent, has been collected during the Biden administration.

Along the same lines, noted bond investor Bill Gross recently told the Financial Times that he believes a Trump victory would be “more bearish” and “disruptive” for the bond markets than the re-election of Biden.

“Trump is the more bearish of the candidates simply because his programs advocate continued tax cuts and more expensive things,” Gross said, although he noted that Biden’s presidency had also been responsible for trillions of dollars of deficit spending.

My analysis

I have been saying for several months that inflation breakeven rates seem overly optimistic, making an investment in a Treasury Inflation-Protected Security (current 5-year real yield of 2.09%) more attractive than its matching nominal Treasury (4.33%). And history is on my side. Inflation over the last 5 years, ending in May, has averaged 4.2%. And that is why we have seen a string of favorable returns from 5-year TIPS over the last several years:

I would add the possibility of Republicans controlling both houses of Congress and the presidency, which could — ironically — tamp down GOP efforts to control the federal deficit. Having a divided Congress can help control government spending and at least force compromises on policy.

In addition, Trump would likely name a new chairman of the Federal Reserve, potentially with a much more investor-friendly policy. In his first term, Trump consistently pushed the Fed to lower interest rates, and that would likely continue.

Both Trump ($2.2 trillion stimulus package) and Biden ($1.9 trillion) deserve blame for the recent surge to a 40-year high in U.S. inflation, along with Congress for approving massive deficits and the Federal Reserve for keeping interest rates too low for too long and then failing to end bond-buying quantitative easing.

The fact is, I believe that no matter which candidate is elected, we will see higher-than-expected inflation over the next four years.

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.