Off the TIPS

There’s a lot of talk about inflation recently. It arguably played a role in the market’s recent downturn as treasury yields rose in response to inflation fears. Is inflation a real threat right now? Is hyperinflation imminent? TIPS are tipping towards the answer being no.

Defined as a general increase in the price of goods and services and a subsequent decrease in the buying power of a currency, it can understandably be difficult to see inflation in real-time. Sure, the price of zoo admission may be more expensive this year but cars are generally getting cheaper. While we may not realise inflation in the moment, we can get an instant gauge on its level through financial instruments.

By now you’d be aware that the value of money erodes over time through inflation. A 1% yielding bond is losing real value if inflation is at 2%. Before we get into the nitty-gritty on bonds, here’s a quick primer.

To counteract this risk, the government offers Treasury Inflation-Protected Securities. They’re 5, 10, or 30-year bonds that increase in value as inflation rises. Given the benefit of inflation protection, they trade at a lower yield than regular bonds of the same duration.

Now, by looking at the value of these bonds we can determine what investors calculate the US inflation rate to be. The spread between a regular 10-year treasury bond and a 10-year TIPS bond indicates expected inflation.

The spread between the 10-year TIPS and 10-year sits at 2.2%. Expected US inflation is well within general global targets of 2-3% and is not unreasonably higher than inflation rates over the last decade. While this may be true, the spread (inflation expectation) is rising which may have investors spooked.

For those looking for access to TIPS through equity markets, check out these ETFs: $TIP, $SPIP, and others on Stake. Do your own research before any investments.