TIPS yields - why similar at different maturities?

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Tyr0ne
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TIPS yields - why similar at different maturities?

Post by Tyr0ne » Fri Oct 30, 2015 5:01 pm

I recently noticed the convergence of TIPS yields at different maturities. I am not sure how long it has been this way, but I am having a hard time reconciling what it all means.

Vanguard Short-Term Inflation-Protected Securities Index Fund Admiral Shares -- 30-Day SEC Yield: .36%
Vanguard Inflation-Protected Securities Fund Admiral Shares -- 30-Day SEC Yield: .39%
PIMCO 15+ Year U.S. TIPS Index Exchange-Traded Fund -- 30-Day SEC Yield: -.45%

(Are 30 Day SEC Yields even relevant in TIPS funds?)

What does this tell us about inflation expectations, yield curve expectations, term premiums, etc.? Why would I want to own a 10-year TIPS yielding the same as a TIPS bond maturing in 2 years?

Any input appreciated!

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Last edited by Tyr0ne on Sat Oct 31, 2015 11:39 am, edited 1 time in total.
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Re: TIPS yields - why similar at different maturities?

Post by abuss368 » Fri Oct 30, 2015 5:22 pm

I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
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Re: TIPS yields - why similar at different maturities?

Post by dangerous » Fri Oct 30, 2015 5:25 pm

Because its inflation protection. Sometimes people want to speculate on average inflation over 10 years not 2 years, etc... Also those yields aren't exactly the same, lots of the yield curve is actually inflation expectations. If real yields aren't expected to go up, the yield curve on TIPS should be very flat.

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Re: TIPS yields - why similar at different maturities?

Post by alex_686 » Fri Oct 30, 2015 5:40 pm

The primary factor driving TIPS yields in the required real interest rate demanded by investors.

Right now the required return on a 10 year treasury, after factoring out inflation expectations, is between .5% and 1% - so basically zero. Short terms would have lower real rates - so also basically zero. So TIPS real rates should also be about zero.

Inflation expectations can be mostly ignored. The longer the maturity the more valuable the inflation protections becomes for unexpected inflation, pushing yields down. However, you can't push yields below zero. With real yields already so close to zero you can't push it down much more.

Side question, I always assumed that yields on TIPS were always tightly grouped. Does anybody know of a formal measure for this?

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Re: TIPS yields - why similar at different maturities?

Post by dodecahedron » Fri Oct 30, 2015 7:06 pm

alex_686 wrote:The longer the maturity the more valuable the inflation protections becomes for unexpected inflation, pushing yields down. However, you can't push yields below zero. With real yields already so close to zero you can't push it down much more.
Real yields can certainly be pushed below zero. If enough people are sufficiently anxious about long term inflation, they may be willing to accept negative real yields. In fact, real yields HAVE been negative on some TIPS at various times in recent years. The TIPS market has fairly arbitrarily limited supply. The Treasury Department determines the number of inflation protected bonds it intends to sell (by some inscrutable decision process) and that's what is available. If there is little demand for them (as was true in the early years, because they were new and a lot of folks didn't quite know what to make of them, plus folks at the time were far more excited about investing in tech stocks), then real interest yields will be relatively high. As demand grew, yields fell. Unclear where it is going in the long run. (Or what Treasury will decide about supply.)

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Re: TIPS yields - why similar at different maturities?

Post by Phineas J. Whoopee » Fri Oct 30, 2015 7:57 pm

I agree with dodecahedron, and would like to add that when people talk about bond yields, unless they specify otherwise they're normally assumed to be talking about Yield to Maturity, YTM.

YTM takes into account the difference between the current market value of the bond and its par value when it matures.

Simply by having their prices bid up TIPS' YTMs, in this case real YTMs, can become negative, because the price is so far above par. Professional participants in the bond market know that, and when they accept negative yields, real or nominal, they do it consciously. In their analysis doing so is better for them than using available alternatives.

Different people value the same thing differently. It's the basis of commerce. Nobody should expect TIPS to make them lots of money. That's not their purpose (although in a nominal sense some scenarios can play out where, under the money illusion, it might look like they did).

TIPS are Treasuries, with interest rate but not credit risk, and are useful for decreasing the inflation risk of a portfolio. That's a reason why a person might hold them, even if some individuals frequently express disdain. I advocate analyzing one's own inflation risk, and using the result to decide on how much, if any, of a portfolio to devote to inflation-linked securities. Those who categorically dislike them are free not to buy them or recommend them to their clients.

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Re: TIPS yields - why similar at different maturities?

Post by Sidney » Fri Oct 30, 2015 8:01 pm

abuss368 wrote:I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
Tips provide insurance. Sames as any insurance -- protection against unexpected events. Tips protect you from unexpected inflation. Nominals already protect you from expected inflation.
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Re: TIPS yields - why similar at different maturities?

Post by Phineas J. Whoopee » Fri Oct 30, 2015 8:26 pm

^ TIPS preserve their purchasing power regardless of inflation, and if bought at auction and held to maturity aren't badly hurt by deflation either.

The expected vs. unexpected inflation question has to do with whether a nominal Treasury or a TIPS with the same maturity will end up having had a higher yield, which can't be known in advance.

TIPS protect one from inflation, expected or unexpected. Nominals pay out the contracted dollar amounts on the contracted dates, regardless of inflation. Buyers of nominal bonds take their expectations for inflation into account when deciding what yields they'll accept, and they don't all agree with each other.

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Re: TIPS yields - why similar at different maturities?

Post by #Cruncher » Fri Oct 30, 2015 8:39 pm

I've corrected the links to the two Vanguard funds, TyrOne. You had them reversed.
Tyr0ne in same post wrote:(Are 30 Day SEC Yields even relevant in TIPS funds?)
Unfortunately, they can be misleading. The PIMCO 15+ fund's reported -0.45% SEC yield is a prime example. The fund holds one TIPS (2032) yielding 0.9% and six (2040-2045) yielding 1.2%. (See WSJ TIPS Quotes 10/29/2015.) Subtracting an expense ratio of 0.2% should produce an SEC yield of about 1.0%. I suspect that PIMCO is including the change in the Consumer Price Index (CPI) -- which makes their reported figure useless in my opinion.

The 0.36% reported by the Vanguard short-term fund is also misleading, but for a completely different reason. The fund holds all 15 TIPS that mature within the next five years and its SEC yield is based on their weighted average yield. But the two TIPS that mature soonest (the January and April 2016's) have abnormally high yields of 2.5% and 1.7% respectively. This arises because of the mechanics of how TIPS principal in adjusted for changes in the CPI. (See this post for more.) After these TIPS mature, the yield of the fund will drop significantly.

In my opinion one gets a better estimate of the fund's ongoing yield by ignoring the TIPS it holds which mature within the next year. According to my post, Re: Consistent Yield & Duration to Help Choose TIPS Fund, as of 10/23/15 the 1-5 index had a yield 0.26% points less than the 0-5 index. Subtracting this from the 0.36% reported by Vanguard, I'd assume an ongoing yield of 0.10% for its short-term fund.

With these better estimates, the SEC yields for the three funds fall into a realistic continuum:

Code: Select all

0.10% VG short-term fund
0.39% VG broad fund
1.0%  PIMCO 15+ fund
Tyr0ne in same post wrote:What does this tell us about inflation expectations[?]
The yields of individual TIPS and TIPS funds tells us nothing about inflation expectations. To get that, look at the difference in yields between nominal Treasury bonds and TIPS of the same maturity.
Tyr0ne in same post wrote:Why would I want to own a 10-year TIPS yielding the same as a TIPS bond maturing in 2 years?
Your supposition is wrong, TyrOne. The two TIPS nearest to maturing in two years, the July 2017 and the January 2018, are currently yielding -0.2% and 0.0% respectively. The two nearest to maturing in ten years, the July 2025 and the January 2026, are currently yielding 0.6% and 0.7% respectively. (See WSJ TIPS Quotes 10/29/2015.)

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Re: TIPS yields - why similar at different maturities?

Post by stlutz » Fri Oct 30, 2015 8:41 pm

I recently noticed the convergence of TIPS yields at different maturities. I am not sure how long it has been this way, but I am having a hard time reconciling what it all means.
The yield curve among nominal bonds (say, comparing the 5 year vs. the 30 year) is flatter now compared to where it was, say,a couple of years ago. TIPS have followed along with this change. In 2015. we've seen the reverse, where 30 year rates have gone up but 5 year rates have not--both with nominals and TIPS. So, in that sense I don't think TIPS are behaving any differently than nominal bonds.

That said, the overall yield curve is flatter with TIPS. The difference between the 5 and 30 with nominals is about 1.4% while it's only about .8% with TIPS. That could either be reflective of:
a) the market believes that inflation will be higher over the next 30 years than over the next 5.
b) the insurance aspect of TIPS--they don't have long-term inflation risk like nominals do, so long-term TIPS should sell at a bit of a discount to nominals.

I personally subscribe to (a) more than (b) as most of the big buyers of LT nominal bonds don't care about inflation as much as you or I do.
I am struggling with why anyone would want to own TIPS at all...
I've recently made somewhat of a market timing move *into* TIPS. While nominal bonds are up this year, TIPS are down. So, I'm selling what is high and buying what is low. Others of course may take a different approach.

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Re: TIPS yields - why similar at different maturities?

Post by lack_ey » Fri Oct 30, 2015 8:49 pm

abuss368 wrote:I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
FWIW their Target Retirement series includes short-term TIPS close to and in retirement. Somewhere around 5 years before retirement, they start adding some (in addition to total bond index and total international bond index), transitioning to a 17% total terminal allocation, 7+ years into retirement.

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Re: TIPS yields - why similar at different maturities?

Post by bs1 » Sat Oct 31, 2015 8:18 am

some of the implications of a flat TIPS curve were discussed by Larry in the comments section here:
http://www.etf.com/sections/index-inves ... s-tips-tip

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Re: TIPS yields - why similar at different maturities?

Post by beardsworth » Sat Oct 31, 2015 9:00 am

abuss368 wrote:I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
Hi abuss368,

Could you explain why you say that Vanguard has "moved away from" TIPS?

Vanguard's short-term TIPS fund is included in Target Retirement 2020, 2015, 2010, and Target Retirement Income (the "final" fund in the Target Retirement series portfolio change glide path). As far as I know, a TIPS fund has never been included in the Life Strategy funds or the Balanced Index Fund, but all of those funds were created before TIPS themselves even existed. Vanguard's other balanced funds have always been actively managed portfolios rather than funds-of-funds.

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Re: TIPS yields - why similar at different maturities?

Post by Johno » Sat Oct 31, 2015 12:27 pm

#Cruncher wrote:
Tyr0ne in same post wrote:Why would I want to own a 10-year TIPS yielding the same as a TIPS bond maturing in 2 years?
Your supposition is wrong, TyrOne. The two TIPS nearest to maturing in two years, the July 2017 and the January 2018, are currently yielding -0.2% and 0.0% respectively. The two nearest to maturing in ten years, the July 2025 and the January 2026, are currently yielding 0.6% and 0.7% respectively. (See WSJ TIPS Quotes 10/29/2015.)
I agree we should reset the discussion by looking at the WSJ link, TIPS curve laid out clearly, rather than trying to read it from sometimes confusing fund info. It's roughly 0.25% in 5yrs, 0.65% in 10 yrs, 1.2% in 30yrs. It's been steeper, but that's not exactly flat. And it stands to reason that the nominal treasury curve would be steeper in terms of difference in yield from say 5 to 30 yrs than the TIPS curve in a time of low inflation if the nominal treasury curve includes a risk neutral expectation of rising inflation plus some version of the same risk neutral expectation of rising real rates you see in the TIPS curve on top of that.

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Re: TIPS yields - why similar at different maturities?

Post by abuss368 » Sat Oct 31, 2015 9:17 pm

beardsworth wrote:
abuss368 wrote:I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
Hi abuss368,

Could you explain why you say that Vanguard has "moved away from" TIPS?

Vanguard's short-term TIPS fund is included in Target Retirement 2020, 2015, 2010, and Target Retirement Income (the "final" fund in the Target Retirement series portfolio change glide path). As far as I know, a TIPS fund has never been included in the Life Strategy funds or the Balanced Index Fund, but all of those funds were created before TIPS themselves even existed. Vanguard's other balanced funds have always been actively managed portfolios rather than funds-of-funds.
Hi beardsworth,

My earlier post was referring to the Intermediate Term TIPS fund. That fund has been replaced with the Short Term TIPS Index Funds in the Target funds close to retirement. The Life Strategy funds include the Vanguard Four Fund Portfolio consisting of U.S. and International Stocks and U.S. and International Bonds only.

Best.
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Re: TIPS yields - why similar at different maturities?

Post by unclescrooge » Sat Oct 31, 2015 10:45 pm

abuss368 wrote:I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
I struggle with why anyone would own international bonds. The yields for 16% of all global debt is negative, and subprime economies like Italy and Portugal have lower yields than the US.
I've replaced my international bond exposure with dollar denominated emerging market bonds with higher yields.

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Re: TIPS yields - why similar at different maturities?

Post by abuss368 » Sat Oct 31, 2015 10:50 pm

Nirav wrote:
abuss368 wrote:I am struggling with why anyone would want to own TIPS at all. Vanguard has moved away from them and recommends Total Bond Index and Total International Bond Index. That provides a lot of diversification.
I struggle with why anyone would own international bonds. The yields for 16% of all global debt is negative, and subprime economies like Italy and Portugal have lower yields than the US.
I've replaced my international bond exposure with dollar denominated emerging market bonds with higher yields.
Did that not increase the overall risk to the safe portion of your investment portfolio?
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Re: TIPS yields - why similar at different maturities?

Post by unclescrooge » Sun Nov 01, 2015 12:25 am

abuss368 wrote:
Nirav wrote: I struggle with why anyone would own international bonds. The yields for 16% of all global debt is negative, and subprime economies like Italy and Portugal have lower yields than the US.
I've replaced my international bond exposure with dollar denominated emerging market bonds with higher yields.
Did that not increase the overall risk to the safe portion of your investment portfolio?
US treasures are safe. I'm not talking about replacing those.

Just the ibonds.


I wouldn't consider iBonds with zero yields, or negative yields safe. If they're not safe, I might as well get as much yield as I can, especially if they investment grade.

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Re: TIPS yields - why similar at different maturities?

Post by Valuethinker » Sun Nov 01, 2015 1:16 pm

Nirav wrote: I've replaced my international bond exposure with dollar denominated emerging market bonds with higher yields.
If that is corporate EM bonds then a lot of alarm bells have been sounded by the likes of the IMF over this subsector. There are big risks here.

If it is EM governments then much depends in which EM. But there are a group of current account deficit countries (South Africa, Turkey etc.) that could get into a real mess if US tightening goes faster than expected. In addition, the fall in commodity prices is really starting to hurt some countries.

Remember an EM borrowing in dollars is basically in the same position as the government of Greece or Portugal. They don't control the currency in which they borrow. If their currency/ economy falls out of bed, the flight to safety can crush them (soaring bond yields, which they cannot then refinance when the bonds come due). Foreign currency reserves help, but they are not a full and final solution.

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Re: TIPS yields - why similar at different maturities?

Post by Kevin M » Sun Nov 01, 2015 1:57 pm

Basically OP is asking about the TIPS (real rates) yield curve. I would use TIPS yields from FRED to see yield curve changes over time, rather than relying on SEC yields of TIPS funds.

Depending on portion of real yield curve you're interested in, you can subtract the shorter maturity from the longer maturity to easily see yield curve trend for that portion. The higher the value, the steeper the curve. For example, here is 30yr minus 5yr for last five years:

Image

We can see that the 30yr-5yr curve has flattened quite a bit since 2013, but in 2015 it actually has steepened from a spread of 0.35 percentage points to 0.9 pp as of Thursday. We can get the latest day data at Daily Treasury Real Yield Curve Rates, and see that as of Friday the 30yr-5yr spread is 1.19 - 0.32 = 0.87 pp.

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Re: TIPS yields - why similar at different maturities?

Post by unclescrooge » Tue Nov 03, 2015 12:55 am

Valuethinker wrote:
Nirav wrote: I've replaced my international bond exposure with dollar denominated emerging market bonds with higher yields.
If that is corporate EM bonds then a lot of alarm bells have been sounded by the likes of the IMF over this subsector. There are big risks here.

If it is EM governments then much depends in which EM. But there are a group of current account deficit countries (South Africa, Turkey etc.) that could get into a real mess if US tightening goes faster than expected. In addition, the fall in commodity prices is really starting to hurt some countries.

Remember an EM borrowing in dollars is basically in the same position as the government of Greece or Portugal. They don't control the currency in which they borrow. If their currency/ economy falls out of bed, the flight to safety can crush them (soaring bond yields, which they cannot then refinance when the bonds come due). Foreign currency reserves help, but they are not a full and final solution.
Valid points. But all equally applicable to international bonds.

The bonds are mostly government.

The US dollar cannot strengthen forever.

Just read an article where the average yield on an International bond funds was 1.5% vs 3.8% for emerging markets. If I'm taking similar risks, I'd rather be well compensated for it.

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