Why are TIPS (real) yields so HIGH???!!!

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zalzel
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Why are TIPS (real) yields so HIGH???!!!

Post by zalzel »

As of 3/13/2008 P.M.

5yr Treasury:................. 2.38%
5yr TIPS:-------------------0.15%
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5yr Inflation expectation= 2.23%


10yr Treasury: --------------3.56%
10yr TIPS:--------------------1.05%
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10yr Inflation expectation= 2.51%

If inflation turns out to be higher than these expected figures, TIPS holders will do better than holders of nominal Treasuries. If holders of nominal Treasuries are worried about higher inflation than the figures above, why are they not buying TIPS, and bidding down the real TIPS yields further?

There is something quite unsettling about this. It appears to me that the Market is expecting that a very poor economy will temper the Feds inflationary actions.

Otto has kindly provided me his alternative view on this in: http://www.diehards.org/forum/viewtopic ... 073#173073. I would be interested in any other opinions out there.

Z.

P.S. Since posting the above, I see that Les has posted links to a very interesting analysis bearing on the above question. His post is at: http://www.diehards.org/forum/viewtopic.php?t=14705

Edited to add P.S.
Last edited by zalzel on Fri Mar 14, 2008 1:09 pm, edited 1 time in total.
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drjdpowell
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Re: Why are TIPS (real) yields so HIGH???!!!

Post by drjdpowell »

zalzel wrote:If inflation turns out to be higher than these expected figures, TIPS holders will do better than holders of nominal Treasuries. If holders of nominal Treasuries are worried about higher inflation than the figures above, why are they not buying TIPS, and bidding down the real TIPS yields further?

There is something quite unsettling about this. It appears to me that the Market is expecting that a very poor economy will temper the Feds inflationary actions.
The market doesn't appear to be worried about high inflation. Nor has it been for years, as the spread between TIPS and Treasuries has traded in a band of about 2.5 to 3 for a long time.

Another possible explanation is that the Fed isn't taking any "inflationary actions". From my limited knowledge, the Fed hasn't increased the money supply much if any in the past few years. All the recent Fed actions seem directed at shifting method in which it provides money (direct lending rather than holding Treasuries) without actually increasing the total amount of money it issues. That isn't "inflationary".

-- James

Another recent conversation of interest: "Is the Fed deflating ?" http://www.diehards.org/forum/viewtopic.php?t=13884
Joe S
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Post by Joe S »

Not an expert, but guess lots of people think inflation and a recession won't mix.
I do know that for most small investors/savers the choice between 5 year treasuries at 2.3% and FDIC-insured CDs at 4% is a no-brainer. Apparently the market is so risk-averse only the super-safest will do.
SmallHi
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Post by SmallHi »

I do know that for most small investors/savers the choice between 5 year treasuries at 2.3% and FDIC-insured CDs at 4% is a no-brainer. Apparently the market is so risk-averse only the super-safest will do.
This of course ignores the ability to take capital gains in Treasuries today (about 15% above a year ago's values) and buy stocks today (both treasury funds and individual securities are much more liquid). I have to assume, relatively speaking, that 1.7% spread can quickly be overcome if one is able to take appreciated bond values (even from these levels -- as inconceivable as that may seem), and buy stocks at prices that are 20% to 30% below their 7-8 month ago values.

Look at it this way, if you are able to move 3-5% of your portfolio out of liquid treasuries and into LV stocks (for example) somewhere near the bottom of this market mess, your potential return is somewhere north of 40% over the next 12 months*. This more than makes up for some interest advantage.

sh

* This qualifies as one of the worst 6 short/intermediate downturns we have seen in the last four decades. The average annualized return on LV stocks in the 12 months after the downturs was almost 41%. Assuming history is some guide as to the magnitude of the recovery (as it was for the downturn), there is some returns to be had for keeping your fixed income liquid, even at these rates!
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BlueEars
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Post by BlueEars »

Another possibility is the standard simple subtraction model we tend to use for TIPS needs to be updated. See here for more details: http://www.diehards.org/forum/viewtopic ... 362#173362
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craigr
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Post by craigr »

I think the reason the real yield on TIPS is so low is because people are willing to give up return for inflation protection right now.

EDIT: In other words, the reasons pointed to in the links Les provided. :)
snowman9000
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Post by snowman9000 »

The Treasury market is not made up of mom and pop investors. There is BIG money there. Meaning organizations with BIG money, like pension funds.

Safety and liquidity today trump inflation worries. Treasuries are a safe, liquid place to be.
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ddb
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Post by ddb »

snowman9000 wrote:The Treasury market is not made up of mom and pop investors. There is BIG money there. Meaning organizations with BIG money, like pension funds.

Safety and liquidity today trump inflation worries. Treasuries are a safe, liquid place to be.
Well, to be clear, TIPs are simply a type of treasuries. However, are you saying that TIPs don't provide the same level of liquidity as a portfolio of traditional treasury notes, given the same maturity? I guess this makes sense logically, as I assume there a lot more traditional treasury bonds out there compared to TIPs. Still, would an insitution with, say, $50 million in 5-year traditional treasuries have superior liquidity than if they used 5-year TIPs instead?

- DDB
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snowman9000
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Post by snowman9000 »

ddb,

I don't have the stats to prove it, but TIPS are a tiny fraction of the Treasury market. Also, they just not as familiar and comfortable. Remember these managers don't get fired for being safe and doing what everyone else does. They get fired for doing something different.
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