Tuesday, October 17, 2023
The move higher in Treasury yields (lower in price) has been unrelenting, with intermediate and longer term Treasury yields bearing the brunt of the move. Rates are moving higher alongside a U.S. economy that has continued to outperform expectations and not due to higher inflation fears. As such, the move higher has been largely driven by an increase in “real” yields, or inflation-adjusted yields or just TIPS (Treasury Inflation-Protected Securities).
TIPS are Treasury securities whose principal and interest payments are adjusted for inflation. Unlike other Treasury securities, where the principal is fixed, the principal of a TIPS can go up or down over its term. So, when the TIPS matures, if the principal is higher than the original principal amount, you get the increased amount. If the principal is equal to or lower than the original principal amount, you get the original amount. So, since these securities are government guaranteed, TIPS investors who hold the individual bonds to maturity receive, at a minimum, the original investment back plus coupons (paid semiannually) but could get more than the original investment if inflation surprises to the upside.
So, after spending years in negative territory, TIPS yields are decidedly positive again for 5-year, 10-year, and 30-year maturities and value has been restored in the TIPS market. Moreover, since 2007, TIPS yields have rarely been higher.
Looking at trailing returns, however, investors may be surprised to see the negative returns generated by the TIPS index (Bloomberg U.S. TIPS Index) despite generationally high inflationary pressures. The challenge for TIPS, has not been the inflationary environment (and thus the adjustment), but rather the aggressive rate hiking campaign by the Fed to arrest those high inflation pressures. And while TIPS provide a hedge against inflation, they do not provide a hedge against higher interest rates. So, with the Fed close to the end of its rate hiking campaign, the volatility experienced in TIPS over the last few years may be coming to an end as well. And with yields at levels last seen in over a decade, TIPS could provide an attractive real return for particularly those investors who can buy and hold individual bonds to maturity.
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Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio as the principal is adjusted semiannually for inflation based on the Consumer Price Index – while providing a real rate of return guaranteed by the U.S. Government.
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