ETFs that invest in Treasury Inflation Protected Securities, or TIPS, have been falling with nominal Treasuries as bond yields rise. The pullback in TIPS is a reminder that these inflation-indexed bonds can also be hurt by higher interest rates.
TIPS did outperform Treasury bonds of similar durations last year as investors bought the securities to protect against inflation amid easy monetary policies from central banks. Yet inflation has not run out of control, at least according to the Consumer Price Index. Of course, many analysts think the government's CPI indicator understates inflation.
Earlier this month, the Labor Department said the Producer Price Index dipped 0.2% in December, compared to the market expectations of a 0.1% drop, reports Jason Lange for Reuters. The decline in overall prices puts the 12-month inflation level at 1.3%, the lowest since July.
Also, the Labor Department revealed that the Consumer Price Index remained unchanged December due to a drop in gasoline prices, Reuters reports. Over 2012, CPI rose 1.7%, the lowest increase since the year through August.
The iShares Barclays Treasury Inflation Protected Securities Bond Fund (TIP) is up 5.6% over the past year. However, TIPS related securities started to weaken after the consumer price report as investors turned to traditional Treasuries in light of the lower inflation levels, reports Cynthia Lin for The Wall Street Journal.
Treasury inflation protected securities, or TIPS, are fixed-income securities that adjust to the Consumer Price Index. Potential investors should monitor the inflation "breakeven rate," or the yield of regulator government bonds against inflation-protected securities for a similar duration. Typically, investors would do better in TIPS if inflation averages more than the breakeven rate.
Rob Brown, chief financial strategist for Equis Capital Management, on Financial Advisors pointed out that after accounting for CPI, TIPS as of the end of last year were "grossly overpriced," with a -1.37% real yield for a 5-year maturity, -1.09% for 7-year, -0.67% for 10-year and 0.15% for 20-year.
Brown also believes that inflation won't be coming back anytime soon as the globe undergoes deleveraging. Other deflationary forces include dropping import prices and flat labor costs.
It's important to remember that TIPS can still be hurt by rising yields like regular Treasury bonds. On Monday, the yield on the 10-year Treasury note rose above 2% for the first time since April 2012.
iShares Barclays Treasury Inflation Protected Securities Bond Fund
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own TIP.