Earlier this month, we observed that the inflation-indexed Treasury market was priced for the assumption that inflation was a fading threat. But since then, the TIPS market appears to be having second thoughts.
On December 4, a 10-year TIPS yielded a real (inflation-adjusted) yield of 2.11%, according to U.S. Treasury data. As of last night’s close, the 10-year TIPS changed hands at 2.50%–the highest since last October.
As our chart below shows, the 10-year TIPS yield has jumped dramatically in recent weeks. Is this a good time to jump in?
Clearly, the bond market generally has become more anxious about inflation’s threat in recent weeks. The nominal 10-year Treasury now yields nearly 4.90%, the highest since last August.
As for TIPS, they now offer the following deal: buy a 10-year TIPS and lock in a real yield of 2.50% for the next 10 years. Will that suffice as compensation for any future inflation?
One way to measure your odds success comes by comparing the higher yieldingnominal 10-year to the 10-year TIPS yield. The spread now works out to 2.40%–the highest since last September. What it means is that as long as top-line consumer prices run below 2.40% for the next 10 years, buying a 10-year TIPS in the here and now will fare worse than buying its nominal equivalent.
For perspective, consumer prices advanced by 2.6% in 2006, down from 3.4% the year before. By that measure, it’s still a close call as to whether TIPS are the better deal at the moment. Unless you’re expecting a material and sustained uptick in inflation in the years ahead from current levels, you’re better off with standard Treasuries.
Perhaps some of the rise in TIPS yield of late is tied to worries surrounding tomorrow’s FOMC meeting, which will issue its latest decision on the price of money. By most accounts, this will be another non-event and Fed funds will remain steady at 5.25%. Fed funds futures are expecting no less, and for well beyond tomorrow’s FOMC confab.
Of course, keeping rates steady if inflation’s set to rise could easily stir TIPS buying. That doesn’t mean the TIPS buyers are any smarter than the rest of the market, but it may explain the jump in TIPS yield of late.
Nonetheless, the wider market will need more convincing evidence that inflation’s still bubbling. The next opportunity for reading inflation’s tea leaves comes on February 21, when the Labor Department dispenses the January report on consumer prices.
Meanwhile, the TIPS market is looking anxious. If the anxiety keeps stirring, the real yield on a 10-year TIPS will be too good to pass up, even if inflation’s not about to skyrocket. For our money, a jump to a 3.0% yield on a 10-year TIPS would convince us to reconsider the asset class. Meanwhile, we’re just lukewarm, but we’re watching.