want to hedge inflation?
treasury inflation-protected securities (TIPS) are one way to do it. quick thread on how they work and when they outperform
the principal of a TIPS bond is adjusted with inflation. these tables show the cash flow differences vs. regular treasuries
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short-term TIPS are highly correlated to unexpected inflation
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the breakeven rate is the level of inflation where TIPS and treasuries earn the same return
right now that’s 1.5% for the 5yr. TIPS are no longer the screaming buy they were in march
but if you think inflation over the next 5yr will be >1.5% then TIPS can still make sense
3/7
TIPS offer unlimited potential outperformance over Treasuries in inflationary environments
but regular treasuries only offer limited outperformance over TIPS in deflationary environments
this is because TIPS have a "deflation floor"
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TIPS do have their downsides:
- the market is thin so they tend to get hit in liquidity crunches
- they’ve historically been more correlated to stocks than regular treasuries
- like all non-muni bonds, they’re tax-inefficient
5/7
series I bonds are a better version of TIPS
they have a fixed rate + inflation adjustments like TIPS. best of all, the return isn't taxable until you redeem the bond
I bonds are attractive when their fixed rate is higher than TIPS real yields. like now
6/7
TIPS tend to outperform regular Treasuries after periods of low breakeven inflation rates
they've only been around since 1997 so unfortunately we don’t have a lot of data. but in plain english, when nobody is pricing in inflation risk TIPS tend to do well
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and if you want to read more I wrote a post series on TIPS
movement.capital/history-of-tip…
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