Friday, April 3, 2009

TIPS Rockin'

Vix and More (hat tip Abnormal Returns) details:

One excellent way to protect against inflation is through the use of Treasury Inflation-Protected Securities, more commonly known as TIPS. As I noted last September in Treasury Inflation -Protected Securities and Inflationary Expectations, TIPS utilize the CPI as an inflationary benchmark and TIPS coupon payments and the underlying principal are automatically adjusted to account for inflation.


After underperforming Treasuries in 2008 (the 5 year duration TIPS index underperformed the 5 year duration Treasury index by 15%), TIPS have come out on fire in 2009, especially following the March 18th announcement that TIPS would be part of the Fed's quantitative easing. With performance that strong, expect investors to chase return, while those looking to lock in 1-2% real return annualized over the next 5 years will keep prices steady in the short-run.

Longer run, I'm not a huge fan as the adjustment to principal is based on CPI (i.e. a government figure). Just last year when the price of food and energy was skyrocketing, CPI only rose slightly. Does anyone expect something different next time around?

4 comments:

  1. "Just last year when the price of food and energy was skyrocketing, CPI only rose slightly. Does anyone expect something different next time around?"

    I like TIPS as insurance. Even if there's limited upside until we actually see some bad inflation, I expect TIPS to "outperform" inflation because of the substitution effect and how I think a high inflation scenario will likely play out.

    Just like you mentioned, some items in the CPI basket will inflate in price more than others. People will tend to substitute or conserve where they can out of the highest priced goods, but the CPI won't do any substituting, so I think it will outperform inflation for the guy on the street's purchasing in general.

    In addition, in a really bad inflation scenario, I expect the government to intervene very strongly in things like agricultural subsidies to try to keep people close to the poverty line out of starvation. Again, I think CPI would outperform what your basic needs will be if it gets really, really bad.

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  2. I agree that TIPS will outperform Treasuries. But I do think Treasuries will have negative real returns over the next 5-10 years so that is not saying much...

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  3. I agree treasuries could see real negative returns from where they are, and in that case, TIPS will most likely also be outperforming treasuries.

    But I'm saying if TIPS start paying out on their CPI triggers, I think they're going to outperform the inflation that CPI tries to approximate.

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