The markets have not been kind to TIPS (Treasury Inflation Protected Securities) thus far in 2013. The TIPS market has a year-to-date total return of -1.2%, with the 10-year and longer maturities showing a total return of -2.8%. This is probably surprising to many investors who had become accustomed to very good returns from TIPS over the past four years. But that was a period of mostly declining Treasury yields and an (irregular) trend toward wider negative yield spreads between TIPS and nominal Treasuries.
Here’s why TIPS haven’t been performing well:
Over the past three months Treasury yields have trended higher and that has pulled TIPS yields upward. Yields on TIPS can withstand a rise in nominal yields if, at the onset, TIPS spreads are relatively narrow, namely, if TIPS are cheap versus the nominals. Since last November, however, those spreads have not been narrow. The range for the spread of 10-year maturities over the past four years has been approximately -175 to -255 basis points. Over the past three months, the spread has been around -250 basis points, at the bottom of that range. If there is resistance to a further widening of spreads, a rise in nominal yields will encourage an equivalent rise in TIPS yields.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.
- Low inflation is also hurting the return on TIPS. During most of 2011 and the early months of 2012, the year-over-year increase in the Consumer Price Index (CPI), which is used for the principal adjustments on TIPS, was around 3%. It is now 1.7-1.8%. If the adjustment does not increase and TIPS yields stay around current levels, total returns over the next twelve months would be close to zero on 5-year TIPS and around 1% for the 10-year TIPS. These are not the returns investors might be anticipating for securities that are supposed to protect them from inflation.
Can TIPS recover?
To be sure, the CPI might increase more rapidly in 2013 than over the last twelve months if energy prices or food prices were to rise. These are the most volatile components of the index. A greater year-over-year increase in the CPI would enhance the returns from TIPS. But with global economic growth still anemic, with labor costs flat and growth in the money supply moderate, it is difficult to see why inflation should increase significantly.
Or, if Treasury yields were to decline as they did last spring, TIPS yields would probably also decline, boosting total returns. Over the past three years, sharp declines in Treasury yields have usually been associated with financial problems overseas and the consequent flight to the relative safety of Treasuries. Another such episode cannot be ruled out in 2013. Without that, however, the returns from TIPS are likely to remain disappointing.