Why TIPS Are Still Better than Nominal Treasuries

RIAanalyst.com - Commentary: A lot of talk this week about spiking long treasuries and the inflation threat. So, we figured we’d run our tips-based inflation expectations model just to to see what things look like. So far things look mostly like a return to normalcy, with a 2.2% long-run inflation expectation, up from 1% just 6 months ago. Of course you have to pass through “normal” in getting from one extreme to the other, so who knows. From an investment perspective, we think we’ll be extremely lucky to have annualized inflation for the next 20 yrs of less than 3%, given monetary and fiscal policy, so we still think TIPS (TIP) are attractive relative to nominal treasuries (IEF).

Inflation Expectations as of 6/11/2009

The 5yr TIPS-implied inflation expectation as of 6/11/2009 is 1.8%/yr. This compares to the minimum in the last 5 years of -0.4%/yr, which occurred 6 months ago (12/12/2008), and to the maximum in the last 5 years of 2.5%/yr, which occurred 5 years ago (6/7/2004).

The 20yr TIPS-implied inflation expectation is 2.2%/yr. This compares to the minimum in the last 5 years of 0.9%/yr, which occurred 6 months ago (12/12/2008), and to the maximum in the last 5 years of 2.6%/yr, which occurred 3 years ago (6/7/2004). For more details see the charts below (click for full size)…

Note: “Impled Inflation” = [(1+nominal)/(1+real)-1], aka “Break-even Inflation”. If actual inflation proves to be more than “break-even”, you are likely to achieve a higher total return holding TIPS rather than Nominal US Treasuries (IEF) and vice versa.

Data source: ustreas.gov

Formatted PDF

Previous inflation-expectation posts can be found here.

Disclosures: No positions in TIP or IEF

Comments

[Larry House:]

TIPS are one asset that fit in any portfolio. They make more sense than treasuries for sure.

Jun 15 10:19 AM

[Heaven, Hel...:]

Interesting to see that with all the concern about inflation, the risk has not yet been priced into the Treasury curve. That said, the Nominal-TIPS spread has increased significantly since the beginning of the year, when there was still talk about deflation. So if the trend is your friend......

I noticed that the spread was a bit volatile at the end of last week, based on the results of the 10-yr and 30-yr auctions. Each longer-term auction seems to bring with it a set of jitters with the yields moving a fair amount either way, depending on the results. I find it concerning that with all the incremental supply that is coming online, there is so much focus on each auction, i.e., every time an auction doesn't "fail", there seems to be a collective sign of relief. I feel like we are only in the second inning of the game, yet the tension is equivalent to that of the later innings already.

Jun 15 10:55 AM

[coloneldebu...:]

In theory these would be a very valuable investment instrument, but you're trusting the government to be honest with you in terms of what factors determine the inflation rate.

As long as the group paying the interest on these bonds also gets to determine the variable part of the interest payment I think I'll pass.

Jun 15 03:07 PM

[ETF Grind:]

Why invest in treasuries at all?

There are much better government bonds out there. Try the WIP.

Jun 18 11:35 PM