Inflation Protection Is Getting More Expensive - Is It Worth It?

by: Tipswatch


TIPS yields have fallen much more sharply than the overall Treasury market.

The five-year TIPS yield has fallen into a negative number, again.

While TIPS remain inexpensive versus Treasurys, the yields today aren't appealing.

Back on Jan. 21, I bought a new 10-year Treasury Inflation-Protected Security at auction with a real yield (after inflation) of 0.725%, highest in nearly five years.

Now, four months later, that same TIPS is trading on the secondary market with a yield of 0.20%, a whopping 52 basis points lower. While I paid about $98.95 for $100 of value at auction - because of the TIPS' coupon rate of 0.625% - buyers today would be paying about $104.01. That's about 5% higher.

TIPS have gotten a lot more expensive in the last four months. Why? There are two basic reasons:

Reason 1. TIPS are following the overall trend of declining Treasury yields. If you look back to January 21, a nominal 10-year Treasury was yielding 2.03%. Today, it is yielding 1.79%, a drop of 24 basis points.

And if you look at the yields being paid around the world for government debt, you can see why money would be flowing into U.S. Treasurys, which remain among the world's safest investments. For example:

  • In Switzerland, a 10-year government bond is yielding -0.37%.
  • In Japan, -0.09%.
  • In Germany, 0.17%.
  • In the Netherlands, 0.39%.
  • In France, 0.52%
  • In Italy, 1.38%.
  • In the United Kingdom, 1.43%.
  • In Spain, 1.53%.
  • In South Korea, 1.78%.

It is going to be difficult for Treasury yields to rise significantly when rates are being held at extremely low levels by government intervention across the globe.

Reason 2. Investors are beginning to price in rising inflation, making TIPS more expensive against nominal Treasurys. You can see this by looking at the inflation breakeven rate, which compares a TIPS yield against a nominal Treasury.

On Jan. 21, that TIPS I bought at auction had an ultra-low inflation breakeven rate of 1.30%. A few weeks later, on February 11, the 10-year inflation breakeven rate dropped to a multi-year low of 1.18%. Since then, however, as oil prices have rebounded, the 10-year inflation breakeven rate has risen to about 1.56%. That means, since February 11, TIPS have gotten 38 basis points more expensive versus nominal Treasurys. That's a huge move, but as this chart shows, TIPS remain historically cheap against traditional Treasurys.

10-year Inflation Breakeven rate

So the TIPS market is getting juiced by two factors: Low overall Treasury yields, which also push TIPS yields lower, and higher inflation expectations, which increase demand for TIPS and push yields even lower. TIPS are outperforming traditional Treasurys, as shown in this three-month chart comparing the TIP ETF with GOVT (overall Treasury) and IEI (intermediate Treasury) ETFs:

Treasury ETF comparison

This is great news for holders of TIPS, because your investments got more valuable over the last three months. But it's lousy news for people who want to be net buyers of TIPS, because TIPS just got more expensive.

Do these current yields look appealing to you?

  • Five-year TIPS: -0.17% (The last five-year auction, a December reopening, had a yield of 0.472%).
  • 10-year TIPS: 0.22% (January's 10-year auction had a yield of 0.725% and it reopened in March at 0.315%).
  • 30-year TIPS: 0.89% (February's 30-year auction had a yield of 1.12%).

The easy answer is: No, they do not look appealing. Although TIPS remain cheap against the overall Treasury market, the current yields aren't appealing as we - possibly - enter an era of eventual interest rate increases.

And the other inflation-protected investment, US Savings I Bonds? There will be big news coming Thursday (April 14) with the announcement of March's inflation numbers. That announcement could bring sorry news: 0.0% interest for six months all I Bonds issued since 2008.

I'll be posting an inflation/I Bond analysis Thursday morning, along with an analysis of April's upcoming five-year TIPS auction.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.