When Inflation Surfaced, TIPS Flopped

When Inflation Surfaced, TIPS Flopped

Finally, a good hedge against inflation!

Professional investors immediately take Treasury inflation-protected securities seriously. TPS' counterparts, Series I savings bonds (also known as I bonds or inflation bonds ), raised just $360 million, while in their first full year of operation, TPS raised $31 billion when it launched in 1997.

In other words, mentoring becomes a big deal. why not? Before TPS, there were no reserves designed to fight inflation. Investors can combine occasional inflation hedges, such as gold, energy stocks or perhaps real estate, that may gain higher returns or at least lose less than regular stocks, but are not directly linked to changes in consumer prices. Index are the tips. When the CPI rises, the Treasury increases the principal value of all TIPS by that amount.

TPS has evolved into portfolios created by sophisticated financial advisors and many mutual funds. For example, the Bond Fund of America ABNDX has more than 10% of its assets in TPS, as do the Vanguard Target Retirement 2020 VTWNX and T. Rowe Price Retirement 2020 TRRBX funds. As the last two funds suggest, investment professionals often use TIPS for retirees. Given enough time, stocks are believed to outperform inflation, but retirees may not be so patient. They need protection that works quickly.

Inflation is coming.

Beneficial insurance policies were not used until recently. In the 24 years from January 1997 to January 2021, the annual CPI growth rate was just 2.09 percent. Inflation does not pose any investment risk anyway. Owning 30-day Treasuries is inflation-matched, earning an annualized 1.99%, and owning something a little bolder beats that. Advice is useful in theory but useless in practice.

Then there is a revival of inflation in the spring of 2021. Financial markets were initially skeptical about the sustainability of inflation; Despite the CPI increase, stocks are expected to remain strong through the end of 2021, while bonds are stable. In fact, the yield on the typical 10-year Treasury note was lower on December 31, 2021 than it was on April 12 of that year, a day before the Labor Department announced what would likely be more inflation. .

Everything has changed in the new year. In January, stock and bond prices fell, which has continued to this day. The reason: Inflation has been higher than economists expected, prompting the Federal Reserve to raise interest rates more than expected. Finally, the tips have their time! Their inflation protection is already showing its value.

Tips haven't done much worse than traditional Treasuries that would have destroyed them in times of inflation.

Year-to-date returns through October 25, 2022 for the Morningstar 1-5 and 5-10 year indexes, relative to the same maturity as the TIPS index.

what happened

Bond products are divided into two. It is called 1) inflation and 2) the remaining real output. With a classic bond, these two components are hidden, because the bond is valued at a single digit, nominal yield. A bond with a yield of 4% can expect future inflation of 3%, thus giving a real yield of 1%. Or it may predict 2% inflation, which means real output is 2%. Any combination that increases up to 4% will explain the value of this stock.

But with TPS, the numbers speak for themselves. Since all TIPS adjust for inflation, you can use the value of the TIPS to calculate your real income. The result shows how popular the tips are, how fashionable they are. A large real yield means investors are reluctant to own TPS unless they receive a return that exceeds future inflation. Conversely, a negative real yield indicates that buyers are willing to relinquish their purchasing power because they want tips. They are, to use my colleague Paul Kaplan's phrase, "willing victims" of the market.

The latter, frankly, is strictly incorrect. If the real yield on TPS turns negative, investors holding these securities can sell them at a profit. If you don't hold tips to maturity, your final total return will be uncertain as market decisions will affect your results.

This is exactly what happened, but in reverse. From spring 2020 to December 2021, TIPS was extremely expensive, posting its deepest negative return. That premium dropped significantly this year. In just nine months, TIPS have gone much cheaper than anywhere else in the past decade. The chart below shows actual 10-year TIPS yields over the past decade. The story is the same for the five and 30 year versions.

Real monthly returns on 10-year tips from November 2022 to October 25, 2022.

Catch the guards

Join the crowd if you find it strange that stocks designed to fight inflation are the only ones to counter this phenomenon. While investment experts recognize that market activity can disrupt the inflationary outlook, few (if any) anticipated this level of carnage, either in this New York Times article or Charles Schwab's SCHW note. on the contrary. When CNBC talked to several experts about "where to put your money during inflation" a year ago, the main consensus was… advice.

The good news for investing is that after enduring such heavy losses (especially 30-year TPS, which lost a third of their value this year), tipping can be a good deal. Next Tuesday's column will examine whether that is the case or whether the proposition still needs to be cheap enough to justify the purchase.


Technically, as some writers suggest, TIPS respond to rising inflation or rising interest rates as opposed to expected inflation. I present this discussion for two reasons. First, it's easy because even the people who made the distinction didn't expect the edge to fall so dramatically. Second, even if true, this argument does not explain why TIPS failed. We have to believe that investors raised their inflation expectations last year only to revise them in 2022. That seems highly unlikely.

However, understanding why the recommendation is weak is a topic for another long article. Suffice to say they have.

This article incorrectly states that the Treasury announced on April 12. It was the Ministry of Labour.

'Double-edged sword' inflation outlook foreshadows impending Fed rate cut: Strategist

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