Real Yields Dropping: Playing The TIPS Market Through SCHP

Summary

  • Treasury Note prices have surged as fears transition from inflation to recession.
  • Real yields are well off their highs, leading to underperformance of TIPS funds vs comparable-maturity Treasurys.
  • Look for volatility this week as the Fed is expected to hike its policy rate by 0.75 percentage points.

US Treasury Department Washington DC

Mo Semsem

Ahead of a pivotal Fed meeting on Wednesday, bond traders appear to believe that interest rate cuts are on the horizon soon after this year’s tightening cycle. Currently, the market prices in nearly three rate cuts in 2023 after the policy rate may peak in the 3.25% to 3.50% range later this year.

0.75% of Rate Cuts Discounted in 2023

0.75% of Rate Cuts Discounted in 2023

Christophe Barraud

The CME FedWatch probabilities chart shows interest rate increases at each of the following three Fed meetings before a pause and possible loosening cycle next year.

Traders See Fed Funds Peaking Near 3.5% in 2022

Traders See Fed Funds Peaking Near 3.5% in 2022

CME Group

Treasurys have caught a major bid over the last six weeks. Since the last time the FOMC gathered, the U.S. 10-Year Note’s yield has dropped from about 3.50% to near 2.75% last week, according to The Wall Street Journal.

Treasury Note Yields Drop Markedly Off the June Peak

Treasury Note Yields Drop Markedly Off the June Peak

WSJ

Right now, the yield curve is the most inverted it has been since 2000, a clear sign that bond traders see recession risks rising. The good news for savers is that while inflation is still cooking at 9.1% (year-over-year through June), short-term Treasury securities yield about 3.0% - the highest since 2001.

Savers Rejoice: 1-Yr Treasury Rate Now Above 3%

Savers Rejoice: 1-Yr Treasury Rate Now Above 3%

CNBC

All these monster moves in Treasury Bills and Notes come as inflation fears ease. The five-year breakeven inflation rate, according to trading markets, notched a fresh 10-month low last week at 2.56%, down one percentage point from the high earlier this year. The “5y5y” forwards also retreated off the year-to-date zenith near 2.6%. A popular investment, along with Series I Savings Bonds, had been owning inflation-protected U.S. Treasury securities through various ETFs. One ETF is among the most liquid and lowest cost you’ll find: the Schwab U.S. TIPS ETF (NYSEARCA:SCHP), much less expensive than the popular iShares TIPS Bond ETF (TIP).

According to Schwab, SCHP’s goal is to track as closely as possible, before fees and expenses, the total return of an index composed of inflation-protected U.S. Treasury securities. With an average maturity of 8.0 years, it’s a broad gauge of the TIPS market. The ETF wrapper also provides some tax efficiency versus a mutual fund. SCHP features a median bid/ask spread of just 0.02% and an expense ratio of only 0.04%. The weighted average yield to maturity is 2.42% as of March 31, 2022.

The Technical Take

The TIPS ETF sharply beat the iShares 7-10 Year Treasury Bond ETF (IEF) handily from the fourth quarter of 2021 through mid-April this year. Since about Tax Day, however, inflation fears have eased. Ergo, IEF has beaten SCHP. But is now the time to buy the dip (on a relative basis) in SCHP?

TIPS vs Treasurys: Eyeing the Early 2020 Consolidation

TIPS vs Treasurys: Eyeing the Early 2020 Consolidation

Stockcharts.com

I say, “not quite yet.” I think SCHP could fall back to where it stood relative to IEF in mid-late February (about when Russia invaded Ukraine and when commodities began to spike). Until then, relative strength is on the side of plain old Treasurys (IEF). Wednesday’s FOMC interest rate decision could change the narrative – I would be a buyer of SCHP over IEF if we see a further retreat, targeting the 0% real yield rate.

10yr TIPS Yield: A Move Back to 0%?

10yr TIPS Yield: A Move Back to 0%?

TradingEconomics

The Bottom Line

All eyes are on Chair Powell. This week’s Fed meeting should bring about more volatility in the Treasury market. Real yields have eased to about 0.43%, according to Treasury.gov, after approaching 0.80% earlier in 2022. The chart suggests that the rate could drop further to near breakeven, at which time owning SCHP over IEF would make sense.

This article was written by

CFA & CMT Charterholder | Freelance Financial Writer at SoFi & Ally | Investments | Markets | Personal Finance | RetirementI create written content used in various formats including blogs, emails, white papers, and social media for financial advisors and investment firms in a cost-efficient way. My passion is putting a narrative to financial data. Working with teams that include senior editors, investment strategists, marketing managers, data analysts, and executives, I contribute ideas to help make content relevant, accessible, and measurable. Having expertise in thematic investing, market events, client education, and compelling investment outlooks, I relate to everyday investors in a pithy way. I enjoy analyzing stock market sectors, ETFs, economic data, and broad market conditions, then producing snackable content for various audiences. Macro drivers of asset classes such as stocks, bonds, commodities, currencies, and crypto excite me. I truly enjoy communicating finance with an educational and creative style. I also believe in producing evidence-based narratives using empirical data to drive home points. Charts are one of the many tools I leverage to tell a story in a simple but engaging way. I focus on SEO and specific style guides when appropriate. My CFA and CMT backgrounds demonstrate prowess in investment management and my professional experience includes extensive public speaking and communication. Moreover, my extensive university teaching and professional trading experience provide useful skills. Past roles also include heavy use of Excel modeling and chart creation as well as PowerPoint.I am a contributor to The Dividend Freedom Tribe. I am a contributor to Topdown Charts.

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