Real (Inflation-Adjusted) Treasury Yields Remain Elevated

[yankees60]

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Real (Inflation-Adjusted) Treasury Yields Remain Elevated

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At a time of increased uncertainty about inflation, the relatively elevated real yields available in inflation-indexed Treasuries offer a partial antidote of certainty for anxious investors.


Using the 5- and 10-year yields for Treasury Inflation-Protected Securities (TIPS) as proxies, the market is providing real payout rates near the highest level in 16 years. Is it an offer too good to pass up? The answer depends on your expectations and goals.

As a starting point for deciding if it’s timely to lock in current real yields, let’s start with a simple fact: the market is still pricing in a relatively compelling bargain. Although real yields are below recent highs, the current rates are sharply above levels that prevailed over much of the past 15 years.

The 10-year real yield is currently 2.05% (Feb. 21), moderately higher than the 5-year’s 1.68%, according to Treasury.gov. If you buy and hold TIPS at current rates, you’ll lock in the yields through the maturity dates. For instance, buying and holding the 10-year TIPS ensures that you’ll earn a 2.05% real yield for the next decade.

The first step in thinking about whether current real yields are compelling, or not, is comparing the rates with what’s offered through nominal yields. Standard Treasuries for 5- and 10-year maturities are currently yielding 4.34% and 4.50%. The key question: Is it timely to lock in a higher nominal or real yield?

The answer, of course, is that no one knows. Because yields and inflation will fluctuate, and no one really knows in what direction or magnitude, there’s an element of uncertainty that can’t be modeled away. But as we think through assumptions about what could happen, we can decide which set of yields look more compelling. Let’s use the 10-year maturities as an example.

If you buy and hold a standard 10-year Note you’ll earn 4.50% — that’s 2.45 percentage points above what a real 10-year Note offers. Is the higher conventional yield a better deal? A key factor for deciding is your outlook for inflation.

Consider that if inflation is 2.45% over the next 10 years, the nominal and real 10-year Treasuries will generate identical results. (I’m fudging the ex ante math re: performance expectations a bit here for simplicity to make a point.) Note that the yield spread for the current 10-year yield less its inflation-indexed counterpart is also 2.45%, which can be thought of as the market’s implied inflation forecast.

The question is whether your inflation forecast is higher, lower or equal to the market’s outlook? The answer will play a role for weighing the pros and cons of the current real vs. nominal yield.

Another way to think about TIPS vs. standard Treasuries is that each one locks in one form of yield while letting another vary through time. When you buy a nominal Treasury, you’re locking in the nominal yield and allowing the real yield to float. By contrast, when you buy a TIPS you’re locking in a real yield, which allows the nominal yield to vary through time. In other words, standard and inflation-indexed Treasury yields are more or less pure hedges for their counterpart from a yield perspective.

This introduces another dimension that can (and should) influence your decision, namely: What’s your view on the future path of nominal and real yields? For example, buying and holding TIPS today will generate a guaranteed real yield through maturity. Meanwhile, the same investment will generate a changing nominal yield – changes that could be dramatically different vs. current yields. That introduces behavioral risk in the sense that even though you’re comfortable locking in today’s real yield, you may be disappointed with the future nominal yield that the TIPS investment generates.

The main takeaway: real yields, even when relatively elevated, aren’t a free lunch. Rather, these securities offer a way to hedge a particular liability: future inflation. The wisdom of today’s decision can be satisfying, or not, depending on where inflation goes from here. Because the future’s always uncertain, however, the best we can do is make assumptions about what could happen to guide us today.

On that note, the analysis starts from a simple observation: real yields are relatively high vs. the past decade and a half. That’s one reason to consider locking in current real yields, but it’s only a first step in a multi-process review for deciding what’s right for you.

[seajay]

US 8000 tonnes of gold, at $3000/oz is around $770Bn value. The US is running a trade deficit of $1Tn/year. The trend is away from the US Dollar (broken promises etc. such that others are less inclined to accept the US exporting inflation, or applying sanctions, not fulfilling NATO commitments etc.). So countries with a trade surplus with the US (US trade deficit) are more inclined to convert surplus dollars into gold ... buy Comex Options/Futures and ask for delivery of physical gold.

TIPS and ... fire insurance from a arsonists springs to mind. Rather than openly default there are means to default without having "defaulted" - such as via taxation or withdrawal from new issues. In the UK both methods have been applied historically (basic/most-common tax rates of 38% when inflation was into double digits (along with requirements that pension funds hold high weightings of bonds) .... type 'default', or simply not issuing new/replacement (inflation) bonds.

Trump bedding down with Putin, insulting and hurting allies is more inclined to accelerate the demand for US gold (instead of accepting/holding Dollars). It's a playoff whether tariffs applied to countries running with a trade surplus accelerates quicker or slower than the actual decline in US trade deficit, which in part is weighed down by the hatchet cutting of domestic public spending. With (including unfunded) debts of $1M per taxpayer !!! Private sector revenues are also inclined to be hurt as reciprocal tariffs/barriers are erected.

Gold might seem appropriate, however again under times of stress so also are taxes inclined to rise. Instead of confiscation simply raising taxes to punitive levels becomes a no-go barrier (silver or even copper can potentially side step gold 'prohibition').

As ever and diversification is the key. Not too much in any one single asset/currency/risk-factor. That may very well include some TIPS - just not too much.

[ochotona]

I have a Fidelity Charitable account... I want to use it up in 6 years. I just decided, after Friday's US equity dump, "nah, I've had a good run in equities in this account" and I just put it 50% in Money Market and 50% in their U.S. TIPS fund (about 6 year duration). And that's it! The donations are all recurring, and when I'm about 70 it will zero out and that will be the end of it.

At 70.5 I'm switching over to QCDs out of my IRA.

[yankees60]

I have a Fidelity Charitable account... I want to use it up in 6 years. I just decided, after Friday's US equity dump, "nah, I've had a good run in equities in this account" and I just put it 50% in Money Market and 50% in their U.S. TIPS fund (about 6 year duration). And that's it! The donations are all recurring, and someday it will zero out and that will be the end of it.

I established one at Vanguard in 2012. Put it all in money market fund then plus all new contributions. Last December I changed it all to Total Stock Market as I realized it is for the long-term and not my money. Therefore, it should be taking on more risk rather than less risk.