A TIPS Update

Treasury Inflation-Protected Securities (TIPS) have been around for 20 years now. How have they done as an investment? Morningstar.com reviews their performance, the expectations, and when TIPS might be good for a portfolio.

The introduction of TIPS brought with it a market-determined observable real rate of interest, which is what the yield on a TIPS is. If you subtract the TIPS yield from the comparable-maturity nominal Treasury yield, you get the market’s inflation expectation over the period until maturity of these two bonds. This is called “breakeven inflation,” because it is the level of inflation at which returns for the nominal and inflation-indexed bonds should break even. The exhibit below shows how well pricing in the TIPS market predicted subsequent inflation. What you see is the breakeven inflation rate for the following five years, compared with actual realized inflation over that period. Since it’s a five-year prediction, the horizontal axis ends five years ago, when the market was calling for inflation between 2012 and 2017 to be around 1.9% annualized.

  – source: Morningstar