30 yr tips yield: 1% to 0.83% over last 2 weeks!

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grok87
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30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Tue Nov 07, 2017 12:22 pm

Just curious what others think about this drop.

I have some new funds available soon to deploy into 30 year tips. I'm on the fence between buying on the secondary market this year or waiting for the next february auction.

Cheers,
Grok
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Doc
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Tue Nov 07, 2017 1:31 pm

It's the 30 year not the TIPS.

Image

https://fred.stlouisfed.org/graph/?g=fEq4

Consider this my harassment of the 30 year bond idea for the month. :D
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

Pravin Lol
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Pravin Lol » Tue Nov 07, 2017 1:35 pm

1% vs. 0.83% seems tiny. Heck, the TIPS yield any time over the last few years is tiny. For me, yield wouldn't be the reason to have them in a portfolio. They're insurance against unexpected inflation. If inflation is 1-2%, they'll clearly underperform other fixed income. But if inflation spikes then all that other fixed income will take a bath (in that it will fail to keep up with inflation), while your TIPS will do fine.

In other words, it's an insurance policy first, and an income stream a distant second. If you are willing to take the inflation risk, then there are better fixed income options. I'm still a few decades from retirement so I'd rather have the yield. If inflation spikes, my income and the prices of other assets should go up too. But if I were in retirement or close to it I'd want the insurance.

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Tue Nov 07, 2017 1:52 pm

Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

garlandwhizzer
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by garlandwhizzer » Tue Nov 07, 2017 1:53 pm

2% is the minimum real yield I would even consider for purchase of a 30 year TIPS bond. Massive duration risk requires at least that IMO. There is always the chance that you or I won't live for 30 years to wait for maturity in which case duration risk may take a huge bite out of principal value. If you're going to tie up money for 30 years in the bond market, which I don't think is a good idea in the first place, I suggest you do it when interest rates are high, not near historic lows like now.

Garland Whizzer

Pravin Lol
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Pravin Lol » Tue Nov 07, 2017 2:11 pm

grok87 wrote:
Tue Nov 07, 2017 1:52 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
I hear you. But I guess my point is that 5% of bupkes is bupkes...unless you have $500k in TIPS or something.

Valuethinker
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Valuethinker » Tue Nov 07, 2017 2:56 pm

grok87 wrote:
Tue Nov 07, 2017 1:52 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
If my maths is right (1+0.0017)^30 then it is a 5% difference in terminal wealth, assuming the coupons can be reinvested at the same real rate.

That's significant in my books.

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Doc
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Tue Nov 07, 2017 3:20 pm

garlandwhizzer wrote:
Tue Nov 07, 2017 1:53 pm
2% is the minimum real yield I would even consider for purchase of a 30 year TIPS bond. Massive duration risk requires at least that IMO. There is always the chance that you or I won't live for 30 years to wait for maturity in which case duration risk may take a huge bite out of principal value. If you're going to tie up money for 30 years in the bond market, which I don't think is a good idea in the first place, I suggest you do it when interest rates are high, not near historic lows like now.

Garland Whizzer
Hey, I finally got someone else on my side. It's been lonely over here.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Tue Nov 07, 2017 4:05 pm

Valuethinker wrote:
Tue Nov 07, 2017 2:56 pm
grok87 wrote:
Tue Nov 07, 2017 1:52 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
If my maths is right (1+0.0017)^30 then it is a 5% difference in terminal wealth, assuming the coupons can be reinvested at the same real rate.

That's significant in my books.
Thanks Valuethinker. Agree with your analysis.

I would be curious re your opinion on the desirability of a 0.83% 30 year real rate. My understanding is that in the UK long term real rates are very significantly negative, ie -1%, -2% or even lower.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Tue Nov 07, 2017 4:11 pm

Pravin Lol wrote:
Tue Nov 07, 2017 2:11 pm
grok87 wrote:
Tue Nov 07, 2017 1:52 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
I hear you. But I guess my point is that 5% of bupkes is bupkes...unless you have $500k in TIPS or something.
Well let's just say my aim is to source 1/3 of my retirement Income from long term tips. It's the 3-legged stool approach with 1/3 from social security, 1/3 from pension/annuity/tips-ladder, 1/3 from my risk portfolio (using a 4% withdrawal rate).
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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FIREchief
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by FIREchief » Tue Nov 07, 2017 8:14 pm

Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
If inflation is 1-2%, they'll clearly underperform other fixed income.
If inflation is 2%, TIPS will absolutely not underperform nominal treasuries (at any term from 5 years to 30 years currently). If you're introducing agency/corporate/etc. bonds, then we're comparing apples to oranges.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

stlutz
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by stlutz » Tue Nov 07, 2017 8:41 pm

It's always worth remembering that whether to buy now and whether to buy at auction are two different questions. I personally don't see the appeal of buying at auction simply because you don't find out until afterward what the price/yield are. I prefer to buy bonds in the secondary market where I know the exact yield I'm getting.

Plus with TIPS the yield actually tends to be a little higher on the 29 year bond than on the 30 (due to liquidity).

So, if I was building a TIPS ladder (which I'm not), I would purchase 29 year bonds in the secondary market when I was ready/thought it made sense.

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Wed Nov 08, 2017 7:51 am

stlutz wrote:
Tue Nov 07, 2017 8:41 pm
It's always worth remembering that whether to buy now and whether to buy at auction are two different questions. I personally don't see the appeal of buying at auction simply because you don't find out until afterward what the price/yield are. I prefer to buy bonds in the secondary market where I know the exact yield I'm getting.

Plus with TIPS the yield actually tends to be a little higher on the 29 year bond than on the 30 (due to liquidity).

So, if I was building a TIPS ladder (which I'm not), I would purchase 29 year bonds in the secondary market when I was ready/thought it made sense.
Thanks

One thing for folks to be aware of is that on the secondary market one will pay bid/ask spreads. These tend to be a bit wider for tips than normal treasuries...
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Wed Nov 08, 2017 8:30 am

FIREchief wrote:
Tue Nov 07, 2017 8:14 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
If inflation is 1-2%, they'll clearly underperform other fixed income.
If inflation is 2%, TIPS will absolutely not underperform nominal treasuries (at any term from 5 years to 30 years currently). If you're introducing agency/corporate/etc. bonds, then we're comparing apples to oranges.
Agree
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

Valuethinker
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Valuethinker » Wed Nov 08, 2017 9:16 am

grok87 wrote:
Tue Nov 07, 2017 4:05 pm
Valuethinker wrote:
Tue Nov 07, 2017 2:56 pm
grok87 wrote:
Tue Nov 07, 2017 1:52 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
If my maths is right (1+0.0017)^30 then it is a 5% difference in terminal wealth, assuming the coupons can be reinvested at the same real rate.

That's significant in my books.
Thanks Valuethinker. Agree with your analysis.

I would be curious re your opinion on the desirability of a 0.83% 30 year real rate. My understanding is that in the UK long term real rates are very significantly negative, ie -1%, -2% or even lower.
From this side of the pond a positive real rate is a real bonus ;-).

Yes Indexed Linked Gilts, depending on maturity, yield about -1.5% real at the moment. Mind, 10 year nominal gilt is just about 1.0%. CPI inflation is running about 2.9% :? :?

It's not an attractive environment for bonds in the GBP world. Eurozone is even worse (for low credit risk govt bonds i.e. Germany).

(there's a point about ILGs and personal taxation, and to be honest I don't know what it is-- makes them more attractive than they would otherwise be and thus lower yields).

http://monevator.com/bonds-and-bond-funds-taxed/

It appears that gilts are exempt from capital gains, if held individually. And that is different from funds-- for ILGs this is a significant factor.
Index-linked Gilt ETF vs Index-linked Gilt Fund taxation

Some UK-based index-linked gilt funds are exempt from income tax on the inflationary component of interest payments.

In other words, if inflation shot up 5% in a year and the gilt paid 1% interest on top of that, then you’d only pay income tax on the 1% and not the other 5%.

However, offshore index-linked gilt ETFs will generally impose income tax on the whole interest payment

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Wed Nov 08, 2017 10:07 am

Valuethinker wrote:
Wed Nov 08, 2017 9:16 am
grok87 wrote:
Tue Nov 07, 2017 4:05 pm
Valuethinker wrote:
Tue Nov 07, 2017 2:56 pm
grok87 wrote:
Tue Nov 07, 2017 1:52 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
1% vs. 0.83% seems tiny.
Well it's a 5% price move.
If my maths is right (1+0.0017)^30 then it is a 5% difference in terminal wealth, assuming the coupons can be reinvested at the same real rate.

That's significant in my books.
Thanks Valuethinker. Agree with your analysis.

I would be curious re your opinion on the desirability of a 0.83% 30 year real rate. My understanding is that in the UK long term real rates are very significantly negative, ie -1%, -2% or even lower.
From this side of the pond a positive real rate is a real bonus ;-).

Yes Indexed Linked Gilts, depending on maturity, yield about -1.5% real at the moment. Mind, 10 year nominal gilt is just about 1.0%. CPI inflation is running about 2.9% :? :?

It's not an attractive environment for bonds in the GBP world. Eurozone is even worse (for low credit risk govt bonds i.e. Germany).

(there's a point about ILGs and personal taxation, and to be honest I don't know what it is-- makes them more attractive than they would otherwise be and thus lower yields).

http://monevator.com/bonds-and-bond-funds-taxed/

It appears that gilts are exempt from capital gains, if held individually. And that is different from funds-- for ILGs this is a significant factor.
Index-linked Gilt ETF vs Index-linked Gilt Fund taxation

Some UK-based index-linked gilt funds are exempt from income tax on the inflationary component of interest payments.

In other words, if inflation shot up 5% in a year and the gilt paid 1% interest on top of that, then you’d only pay income tax on the 1% and not the other 5%.

However, offshore index-linked gilt ETFs will generally impose income tax on the whole interest payment
Thanks
I wasn't aware of the taxation issue, that's interesting...
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Doc
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Wed Nov 08, 2017 11:23 am

grok87 wrote:
Wed Nov 08, 2017 8:30 am
FIREchief wrote:
Tue Nov 07, 2017 8:14 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
If inflation is 1-2%, they'll clearly underperform other fixed income.
If inflation is 2%, TIPS will absolutely not underperform nominal treasuries (at any term from 5 years to 30 years currently). If you're introducing agency/corporate/etc. bonds, then we're comparing apples to oranges.
Agree
If inflation is at 2% and remains at 2% for 5 to 30 years TIPS will definitely underperformed nominals because TIPS buyers will pay a premium for the inflation insurance in case that inflation rate does not remain below 2%. And that premium means TIPS will underperform because the TIPs cost more for the same return in the end.

It doesn't matter what initial inflation rate is. It only matters if the inflation rate goes up more than the market is currently predicting. The reason to forgo buying 30 year TIPS now is that you are locking in a historically low real rate for thirty years in order to get that unanticipated inflation protection. There is nothing wrong with Grok's approach of creating an inflation protected LMP. It is just very expensive at this time. If inflation increases more than currently anticipated and real rates also increase over the time period it is not possible to pick the TIPS/nominal winner a priori.
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FIREchief
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by FIREchief » Wed Nov 08, 2017 3:47 pm

Doc wrote:
Wed Nov 08, 2017 11:23 am
grok87 wrote:
Wed Nov 08, 2017 8:30 am
FIREchief wrote:
Tue Nov 07, 2017 8:14 pm
Pravin Lol wrote:
Tue Nov 07, 2017 1:35 pm
If inflation is 1-2%, they'll clearly underperform other fixed income.
If inflation is 2%, TIPS will absolutely not underperform nominal treasuries (at any term from 5 years to 30 years currently). If you're introducing agency/corporate/etc. bonds, then we're comparing apples to oranges.
Agree
If inflation is at 2% and remains at 2% for 5 to 30 years TIPS will definitely underperformed nominals because TIPS buyers will pay a premium for the inflation insurance in case that inflation rate does not remain below 2%. And that premium means TIPS will underperform because the TIPs cost more for the same return in the end.

It doesn't matter what initial inflation rate is. It only matters if the inflation rate goes up more than the market is currently predicting. The reason to forgo buying 30 year TIPS now is that you are locking in a historically low real rate for thirty years in order to get that unanticipated inflation protection. There is nothing wrong with Grok's approach of creating an inflation protected LMP. It is just very expensive at this time. If inflation increases more than currently anticipated and real rates also increase over the time period it is not possible to pick the TIPS/nominal winner a priori.
I know you understand our point Doc. OTOH, I really can't figure out what you're saying here. We can't buy bonds in the past or the future, we can only buy them today. The point is, if I want to buy a ten year treasury today, and have chosen 2% as what I expect for inflation, then a ten year TIPS will outperform a ten year nominal treasury. The breakeven inflation rate is currently 1.88% (2.32 - .44). Of course, my inflation expectation won't be correct, it will be either higher or lower. If you can provide data that proves that a 2% inflation estimate is way too high, then sure, I should buy the nominal. But, you can't.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Doc
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Wed Nov 08, 2017 6:06 pm

FIREchief wrote:
Wed Nov 08, 2017 3:47 pm
The point is, if I want to buy a ten year treasury today, and have chosen 2% as what I expect for inflation, then a ten year TIPS will outperform a ten year nominal treasury. The breakeven inflation rate is currently 1.88% (2.32 - .44). Of course, my inflation expectation won't be correct, it will be either higher or lower. If you can provide data that proves that a 2% inflation estimate is way too high, then sure, I should buy the nominal. But, you can't.
It doesn't matter what you or I expect for inflation. It is what the market expects.The breakeven is the market's expectation of the inflation rate over the period adjusted for the insurance premium that the TIPS buyer is willing to forego in case the future inflation rate is higher than what the market expects. If it turns out that the market is correct in projecting the inflation rate than the nominal buyer will get the true real rate plus the true inflation but the TIPS buyer will get less than that because he has paid the insurance premium when he made his purchase.
TIPS should outperform conventional Treasuries when realized inflation is greater than expected inflation plus the risk premium. Note that the expected return of a TIPS should be slightly less than the expected return of a conventional U.S. Treasury of the same maturity because the investors in conventional Treasuries should receive a risk premium for bearing inflation risk.
(Emphasis on plus is from Swedroe/Hempen not me.)

"The Only Guide to a Winning Bond Strategy You'll Ever Need", Larry E. Swedroe and Joseph H. Hempen first Edition p 91

(In case you wonder I keep one copy on my desk and one in the bookcase. After all Larry's only two right turns from my house." :D
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FIREchief
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by FIREchief » Wed Nov 08, 2017 10:34 pm

Doc wrote:
Wed Nov 08, 2017 6:06 pm
FIREchief wrote:
Wed Nov 08, 2017 3:47 pm
The point is, if I want to buy a ten year treasury today, and have chosen 2% as what I expect for inflation, then a ten year TIPS will outperform a ten year nominal treasury. The breakeven inflation rate is currently 1.88% (2.32 - .44). Of course, my inflation expectation won't be correct, it will be either higher or lower. If you can provide data that proves that a 2% inflation estimate is way too high, then sure, I should buy the nominal. But, you can't.
It doesn't matter what you or I expect for inflation. It is what the market expects.The breakeven is the market's expectation of the inflation rate over the period adjusted for the insurance premium that the TIPS buyer is willing to forego in case the future inflation rate is higher than what the market expects. If it turns out that the market is correct in projecting the inflation rate than the nominal buyer will get the true real rate plus the true inflation but the TIPS buyer will get less than that because he has paid the insurance premium when he made his purchase.
This is simply not true if inflation runs 2% for the next ten years. That was my original, and only, point. If the "market determined" inflation rate is currently 1.88% (it is/was as of my post), then if inflation runs 2% the TIPS buyer comes out ahead. The post I originally responded to said that if inflation ran 2%, TIPS would underperform. The facts clearly suggest otherwise.

It continues to baffle me how poorly people in general understand real versus nominal rates.

Put another way, I think that TIPS "insurance" is currently free, because a significant number of buyers are offsetting it with an emotional aversion to facing up to what real rates currently are paying.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

grok87
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Thu Nov 09, 2017 5:54 am

FIREchief wrote:
Wed Nov 08, 2017 10:34 pm
Put another way, I think that TIPS "insurance" is currently free, because a significant number of buyers are offsetting it with an emotional aversion to facing up to what real rates currently are paying.
Agree.

I haven't read the Larry Swedroe source Doc cites. But there are a bunch of federal reserve papers on whether tips breakeven inflation rates (BEI) are a good estimate of expected inflation. A common model is:

Expected inflation = BEI + "tips il-liquidity premium" - "inflation insurance premium"

While the model may seem overly complicated, i like it. It starts with the observation that tips are less liquid than regular treasuries, less trading, higher bid-ask spreads, nasty tax rules.

I think 30 year BEI is about 1.9% right now. My own guess is that the insurance premium is 0, the il-liquidity premium is say 0.25%, and expexted inflation over the next 30 years is 2.15%- ie slighly higher than the fed's 2% target.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Thu Nov 09, 2017 9:20 am

grok87 wrote:
Thu Nov 09, 2017 5:54 am
FIREchief wrote:
Wed Nov 08, 2017 10:34 pm
Put another way, I think that TIPS "insurance" is currently free, because a significant number of buyers are offsetting it with an emotional aversion to facing up to what real rates currently are paying.
Agree.

I haven't read the Larry Swedroe source Doc cites. But there are a bunch of federal reserve papers on whether tips breakeven inflation rates (BEI) are a good estimate of expected inflation. A common model is:

Expected inflation = BEI + "tips il-liquidity premium" - "inflation insurance premium"

While the model may seem overly complicated, i like it. It starts with the observation that tips are less liquid than regular treasuries, less trading, higher bid-ask spreads, nasty tax rules.

I think 30 year BEI is about 1.9% right now. My own guess is that the insurance premium is 0, the il-liquidity premium is say 0.25%, and expexted inflation over the next 30 years is 2.15%- ie slighly higher than the fed's 2% target.
We are now all on the same page. The last hangup is " my own guess". I wouldn't strongly object to the inflation premium being low due to low inflation fears at least on the short end. If that is true then the liquidity factor might also be low because there is little demand also so the size of the market is "good enough". So we are back to the original question. Which is currently better?

Without looking our TIPS position is maybe 10 to 15% of our Treasuries and the longest is 8 years. Unlike Grok we have little need for an inflation protected LMP. I'm currently buying sevens and hence am restricted to the secondary market and I want to avoid ABP hassles on top of the OID so this limits my TIPS. Grok doesn't have the same tax issues.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by FIREchief » Thu Nov 09, 2017 3:21 pm

grok87 wrote:
Thu Nov 09, 2017 5:54 am
I think 30 year BEI is about 1.9% right now. My own guess is that the insurance premium is 0, the il-liquidity premium is say 0.25%, and expexted inflation over the next 30 years is 2.15%- ie slighly higher than the fed's 2% target.
Interesting insight. That makes sense. I'm not sure how much of the TIPS market is retail investors, but if it is significant I still think there is an emotional component (aversion) driven by seeing clear real rates near zero percent.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

Seasonal
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Seasonal » Thu Nov 09, 2017 6:22 pm

grok87 wrote:
Thu Nov 09, 2017 5:54 am
Expected inflation = BEI + "tips il-liquidity premium" - "inflation insurance premium"

While the model may seem overly complicated, i like it. It starts with the observation that tips are less liquid than regular treasuries, less trading, higher bid-ask spreads, nasty tax rules.

I think 30 year BEI is about 1.9% right now. My own guess is that the insurance premium is 0, the il-liquidity premium is say 0.25%, and expexted inflation over the next 30 years is 2.15%- ie slighly higher than the fed's 2% target.
The Fed has been frequently asked how it can predict inflation of 2% when BEI is lower (and was recently noticeably lower). They come up with analyses similar to your guesses, emphasizing the il-liquidity premium. I'd note those analyses have been heavily criticized.

What's your basis for your guesses on insurance premium and il-liquidity premium?

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Thu Nov 09, 2017 6:55 pm

Seasonal wrote:
Thu Nov 09, 2017 6:22 pm
grok87 wrote:
Thu Nov 09, 2017 5:54 am
Expected inflation = BEI + "tips il-liquidity premium" - "inflation insurance premium"

While the model may seem overly complicated, i like it. It starts with the observation that tips are less liquid than regular treasuries, less trading, higher bid-ask spreads, nasty tax rules.

I think 30 year BEI is about 1.9% right now. My own guess is that the insurance premium is 0, the il-liquidity premium is say 0.25%, and expexted inflation over the next 30 years is 2.15%- ie slighly higher than the fed's 2% target.
The Fed has been frequently asked how it can predict inflation of 2% when BEI is lower (and was recently noticeably lower). They come up with analyses similar to your guesses, emphasizing the il-liquidity premium. I'd note those analyses have been heavily criticized.

What's your basis for your guesses on insurance premium and il-liquidity premium?
I would be interesting in reading that diAlogue between the fed and its critica if you have a link or two.


Re the il-liquidity premium, see this paper for example, figure 11.

http://www.frbsf.org/economic-research/ ... 017-11.pdf
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

Seasonal
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Seasonal » Thu Nov 09, 2017 7:12 pm

Here's a random sample: https://blog.pimco.com/en/2016/03/is-th ... rket-data/

Also see https://ftalphaville.ft.com/2015/02/26/ ... reakevens/ "The problem with this explanation of the recent decline in breakevens is that it suggests that TIPS have suddenly became a lot less liquid, perhaps due to crisis-like conditions somewhere in the world. That seems difficult to believe, especially given the behaviour of the stock markets."

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Sammy_M » Thu Nov 09, 2017 7:28 pm

Doc wrote:
Thu Nov 09, 2017 9:20 am
Without looking, our TIPS position is maybe 10 to 15% of our Treasuries and the longest is 8 years. Unlike Grok we have little need for an inflation protected LMP. I'm currently buying sevens and hence am restricted to the secondary market and I want to avoid ABP hassles on top of the OID so this limits my TIPS. Grok doesn't have the same tax issues.
I'm curious, why not CDs over nominal Treasuries? Liquidity?

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Sammy_M » Thu Nov 09, 2017 7:36 pm

I cannot commit to 30 years at current yield levels, but maybe I'll regret that if we experience ILG-like negative real yields in the future.

To me, TIPS look attractive vs. nominal Treasuries, but not to CDs.

On the secondary market, CD NOMINAL less TIPS REAL rate...

1/15/2023 - 2.36
1/15/2024 - 2.49
1/15/2025 - 2.49

With 10yr inflation forecast of 2.25, its around 25bp premium. Perhaps half due to unexpected inflation and half to greater illiquidity of CDs vs. TIPS.

Seems reasonable compensation.

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Thu Nov 09, 2017 7:59 pm

Sammy_M wrote:
Thu Nov 09, 2017 7:36 pm
I cannot commit to 30 years at current yield levels, but maybe I'll regret that if we experience ILG-like negative real yields in the future.

To me, TIPS look attractive vs. nominal Treasuries, but not to CDs.

On the secondary market, CD NOMINAL less TIPS REAL rate...

1/15/2023 - 2.36
1/15/2024 - 2.49
1/15/2025 - 2.49

With 10yr inflation forecast of 2.25, its around 25bp premium. Perhaps half due to unexpected inflation and half to greater illiquidity of CDs vs. TIPS.

Seems reasonable compensation.
Thanks
With CDs don't forget about state taxes.
What is the source for the 2.25% 10 year inflation estimAte? The Philly survey?
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Thu Nov 09, 2017 8:07 pm

Seasonal wrote:
Thu Nov 09, 2017 7:12 pm
Here's a random sample: https://blog.pimco.com/en/2016/03/is-th ... rket-data/

Also see https://ftalphaville.ft.com/2015/02/26/ ... reakevens/ "The problem with this explanation of the recent decline in breakevens is that it suggests that TIPS have suddenly became a lot less liquid, perhaps due to crisis-like conditions somewhere in the world. That seems difficult to believe, especially given the behaviour of the stock markets."
Thanks.
The ft article had a pay wall but I read the pimco one. It was from early 2016 when 5x5 year bei was plunging, down to like 1.5% level.
I think it's around 1.8% now.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Seasonal » Thu Nov 09, 2017 8:47 pm

grok87 wrote:
Thu Nov 09, 2017 8:07 pm
The ft article had a pay wall but I read the pimco one. It was from early 2016 when 5x5 year bei was plunging, down to like 1.5% level.
I think it's around 1.8% now.
The paragraph I quoted was the key to the FT article.

FWIW, I found the article through a Google search and clicking the Google link didn't require registering. Also, it's a register wall, not a paywall.

5 and 10 year BEI is 1.9% and 30 year is 2%

Image

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Sammy_M » Fri Nov 10, 2017 5:43 am

grok87 wrote:
Thu Nov 09, 2017 7:59 pm
With CDs don't forget about state taxes.
What is the source for the 2.25% 10 year inflation estimAte? The Philly survey?
Good point. In my case, they'd be held in tax-advantaged.

Yes, the Philly survey. https://www.philadelphiafed.org/researc ... -forecasts

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Fri Nov 10, 2017 6:26 am

Seasonal wrote:
Thu Nov 09, 2017 8:47 pm
grok87 wrote:
Thu Nov 09, 2017 8:07 pm
The ft article had a pay wall but I read the pimco one. It was from early 2016 when 5x5 year bei was plunging, down to like 1.5% level.
I think it's around 1.8% now.
The paragraph I quoted was the key to the FT article.

FWIW, I found the article through a Google search and clicking the Google link didn't require registering. Also, it's a register wall, not a paywall.

5 and 10 year BEI is 1.9% and 30 year is 2%

Image
Thanks
From the same st louis fed source 5x5 bei is now 1.97% (which is what the fed looks at i think to compare to their 2% inflation target).
https://fred.stlouisfed.org/series/T5YIFR
Again when pimco wrote their early 2016 article it was at 1.5%, so i think pimco had more of a valid argument back then...

Starting with the 1.97% and adding some corection for the illiquidity of tips would get you to long term inflation in the 2-2.25% range (my estimate is 2.15%). This ignores of course any "inflation risk premium" component of tips pricing. With philly fed estimate of 10 year inflationat 2.25% and 10 year bei at 1.9% it doesn't feel like there is much if any of an "inflation risk premium" baked into tips now.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Fri Nov 10, 2017 6:28 am

Doc wrote:
Thu Nov 09, 2017 9:20 am
grok87 wrote:
Thu Nov 09, 2017 5:54 am
FIREchief wrote:
Wed Nov 08, 2017 10:34 pm
Put another way, I think that TIPS "insurance" is currently free, because a significant number of buyers are offsetting it with an emotional aversion to facing up to what real rates currently are paying.
Agree.

I haven't read the Larry Swedroe source Doc cites. But there are a bunch of federal reserve papers on whether tips breakeven inflation rates (BEI) are a good estimate of expected inflation. A common model is:

Expected inflation = BEI + "tips il-liquidity premium" - "inflation insurance premium"

While the model may seem overly complicated, i like it. It starts with the observation that tips are less liquid than regular treasuries, less trading, higher bid-ask spreads, nasty tax rules.

I think 30 year BEI is about 1.9% right now. My own guess is that the insurance premium is 0, the il-liquidity premium is say 0.25%, and expexted inflation over the next 30 years is 2.15%- ie slighly higher than the fed's 2% target.
We are now all on the same page. The last hangup is " my own guess". I wouldn't strongly object to the inflation premium being low due to low inflation fears at least on the short end. If that is true then the liquidity factor might also be low because there is little demand also so the size of the market is "good enough". So we are back to the original question. Which is currently better?

Without looking our TIPS position is maybe 10 to 15% of our Treasuries and the longest is 8 years. Unlike Grok we have little need for an inflation protected LMP. I'm currently buying sevens and hence am restricted to the secondary market and I want to avoid ABP hassles on top of the OID so this limits my TIPS. Grok doesn't have the same tax issues.
Thanks Doc.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Seasonal » Fri Nov 10, 2017 1:11 pm

As of the moment, 30 yr tips yield is 0.91%, making back about half of the lost yield over the last 2 weeks.

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Sat Nov 11, 2017 8:06 am

Seasonal wrote:
Fri Nov 10, 2017 1:11 pm
As of the moment, 30 yr tips yield is 0.91%, making back about half of the lost yield over the last 2 weeks.
thanks- yes i saw that. makes my decision easier...
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Wed Nov 15, 2017 5:46 pm

Back to 0.83%!
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Wed Nov 22, 2017 1:59 pm

Now at 0.82%.

One theory is that corporate pension plans are buying long dated treasuries as they see to de-risk and more fully fund their plans.

https://www.bloomberg.com/amp/news/arti ... ve-flatter
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Wed Dec 06, 2017 1:53 pm

Now at 0.75%!
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by #Cruncher » Thu Dec 07, 2017 11:07 am

The TIPS yield curve has been flattening over the past 8 months as shown by the green line of the difference between the 30-year and 5-year constant maturity rates:

Image

From 4/20/2017 to 12/6/2017 the 30-year yield fell 0.15% points while the 5-year yield rose 0.41% points, a 0.56% point flattening.

Code: Select all

           5 YR  30 YR   Diff
           ----  -----   ----
04/20/17  -0.04   0.92   0.96
12/06/17   0.37   0.77   0.40
Partially in response to this, I'm considering buying at the reopening auction of the 5-year April 2022 tentatively scheduled for Thursday 12/21/17.

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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Thu Dec 07, 2017 12:23 pm

If I am doing this right the nominal curve (red line) is also flattening.

Image

Long data range, sorry. Just look at the right inch.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Fri Dec 08, 2017 7:02 pm

#Cruncher wrote:
Thu Dec 07, 2017 11:07 am
The TIPS yield curve has been flattening over the past 8 months as shown by the green line of the difference between the 30-year and 5-year constant maturity rates:

Image

From 4/20/2017 to 12/6/2017 the 30-year yield fell 0.15% points while the 5-year yield rose 0.41% points, a 0.56% point flattening.

Code: Select all

           5 YR  30 YR   Diff
           ----  -----   ----
04/20/17  -0.04   0.92   0.96
12/06/17   0.37   0.77   0.40
Partially in response to this, I'm considering buying at the reopening auction of the 5-year April 2022 tentatively scheduled for Thursday 12/21/17.
thanks
I agree the 5 year TIP is starting to look interesting. Not a good fit for my retirement Liability matching portfolio but could be useful for other shorter term liability matching.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Fri Dec 08, 2017 7:15 pm

Doc wrote:
Thu Dec 07, 2017 12:23 pm
If I am doing this right the nominal curve (red line) is also flattening.

Image

Long data range, sorry. Just look at the right inch.
thanks. yield curve certainly looking pretty flat these days...
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by jalbert » Fri Dec 08, 2017 9:11 pm

Doc wrote:
Wed Nov 08, 2017 6:06 pm
TIPS should outperform conventional Treasuries when realized inflation is greater than expected inflation plus the risk premium. Note that the expected return of a TIPS should be slightly less than the expected return of a conventional U.S. Treasury of the same maturity because the investors in conventional Treasuries should receive a risk premium for bearing inflation risk.
(Emphasis on plus is from Swedroe/Hempen not me.)
This is not inconsistent with the statement that a TIP will outperform a nominal treasury when inflation turns out to be higher than the breakeven inflation rate for the maturity. The breakeven rate is the nominal yield minus the TIP yield and the nonimal yield incorporates both the expected inflation rate and the inflation risk premium already.

But the TIPs yield also incorporates a liquidity risk premium, so we would need to know that the expected return of the inflation risk premium for a nominal treasury was greater than the expected return of the liquidity risk premium of a TIP of the same maturity to declare that the treasury would have a higher expected return.

One other point is that if you hold a TIP to maturity, you are guaranteed to realize any liquidity risk premium incorporated into the yield, but if you hold a treasury to maturity, inflation has to cooperate for you to receive the full inflation risk premium.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Sat Dec 09, 2017 8:13 am

jalbert wrote:
Fri Dec 08, 2017 9:11 pm
Doc wrote:
Wed Nov 08, 2017 6:06 pm
TIPS should outperform conventional Treasuries when realized inflation is greater than expected inflation plus the risk premium. Note that the expected return of a TIPS should be slightly less than the expected return of a conventional U.S. Treasury of the same maturity because the investors in conventional Treasuries should receive a risk premium for bearing inflation risk.
(Emphasis on plus is from Swedroe/Hempen not me.)
This is not inconsistent with the statement that a TIP will outperform a nominal treasury when inflation turns out to be higher than the breakeven inflation rate for the maturity. The breakeven rate is the nominal yield minus the TIP yield and the nonimal yield incorporates both the expected inflation rate and the inflation risk premium already.

But the TIPs yield also incorporates a liquidity risk premium, so we would need to know that the expected return of the inflation risk premium for a nominal treasury was greater than the expected return of the liquidity risk premium of a TIP of the same maturity to declare that the treasury would have a higher expected return.

One other point is that if you hold a TIP to maturity, you are guaranteed to realize any liquidity risk premium incorporated into the yield, but if you hold a treasury to maturity, inflation has to cooperate for you to receive the full inflation risk premium.
I often get confused with Swedroe's use of "risk premium". Does it refer to the price or the yield. I think at times it gets reversed.

In the case here a TIPS investor expects to receive less if the inflation turns out to be what is expected because he pays an insurance premium for the chance of inflation being higher than expected. But the expected inflation is not the break even because the break even contains the risk premium. So for the TIPS holder to outperform, inflation has to be higher than the break even plus the risk premium. (Now I've committed the yield/price conumdrum.)

I think the confusion here comes from equating the break even with the expected inflation Wich is incorrect because of the inflation and liquidity factors baked into the breakeven.

All this is probably nit picking.

If I was going to buy a thirty year Treasury I wold buy a TIPS for the inflation protection. But I won't buy a thirty because if the term risk associated with changes in the real rate over 30 years.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by jalbert » Sun Dec 10, 2017 5:58 am

With bonds, the inverse relationship between price and yield, means it doesn't matter whether you consider a risk premium to be a discounted price or higher yield.

If, at some point in time, the expected value of the liquidity risk premium of a TIP is higher than the expected value of the inflation risk premium of a nominal treasury of the same maturity, then the expected return of the TIP will be higher at that point in time.
Last edited by jalbert on Sun Dec 10, 2017 7:50 pm, edited 1 time in total.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Sun Dec 10, 2017 6:27 am

jalbert wrote:
Sun Dec 10, 2017 5:58 am
With bonds, the inverse relationship between price and yield, means it doesn't matter whether you consider a risk premium to be a discounted price or higher yield.

If, at some point in time, the expected value of the liquidity risk premium of a TIP is higher than the expected value of the inflation risk premium of a nonimal treasury of the same maturity, then the expected return of the TIP will be higher at that point in time.
+1
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Sun Dec 10, 2017 7:04 am

jalbert wrote:
Sun Dec 10, 2017 5:58 am
With bonds, the inverse relationship between price and yield, means it doesn't matter whether you consider a risk premium to be a discounted price or higher yield.

If, at some point in time, the expected value of the liquidity risk premium of a TIP is higher than the expected value of the inflation risk premium of a nonimal treasury of the same maturity, then the expected return of the TIP will be higher at that point in time.
Agreed. My point was that I've seen it used both ways in the same discussion at times. One way for TIPS and the other for nominals. That sometimes makes the underlying math hard to follow.
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by grok87 » Sun Dec 10, 2017 12:11 pm

Doc wrote:
Sun Dec 10, 2017 7:04 am
jalbert wrote:
Sun Dec 10, 2017 5:58 am
With bonds, the inverse relationship between price and yield, means it doesn't matter whether you consider a risk premium to be a discounted price or higher yield.

If, at some point in time, the expected value of the liquidity risk premium of a TIP is higher than the expected value of the inflation risk premium of a nonimal treasury of the same maturity, then the expected return of the TIP will be higher at that point in time.
Agreed. My point was that I've seen it used both ways in the same discussion at times. One way for TIPS and the other for nominals. That sometimes makes the underlying math hard to follow.
i think technically speaking some academics and the fed define things in this way:
https://www.frbatlanta.org/%20-/media/D ... ations.pdf

Nominal yield - Real Yield = Breakeven inflation = Expected Inflation + "inflation risk premium" - "liquidity premium"

They further have this to say:

"The inflation risk premium appears to be small and stable over time. In fact, our estimate
of the inflation risk premium is negative (although statistically insignificant) which differs
from other estimates reported in the literature. Campbell, Shiller and Viceira (2009) provide
theoretical arguments for low and even negative risk premium of TIPS relative to short-term
safe assets.
As argued earlier, the largest contributor to the recent variability of the TIPS-base
breakeven inflation proves to be the liquidity premium. Our liquidity factor aggregates
a number of specificities and institutional features of the TIPS market that may cause the
observed BEI to deviate from the true BEI. In addition to the relative illiquidity of TIPS to
the Treasury and swaps markets, these factors include indexation lag, deflation floor, tenor-
specific liquidity concentration, carry generated by seasonality of CPI-U, limits to arbitrage,
institutional investors re-allocations and redemptions etc.
Finally, Figure 9 plots the estimated liquidity factor and the spread between the inflation
swaps and TIPS breakeven inflation. As pointed out above, the latter serves as a proxy for the
relative liquidity between the two markets."
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Re: 30 yr tips yield: 1% to 0.83% over last 2 weeks!

Post by Doc » Sun Dec 10, 2017 3:54 pm

Thanks grok,

So do we belive Swedroe/Hempen or the Federal Reserve Bank of Atlanta? :D

No matter which, the breakeven rate does not equal the expected inflation. But it's probably good enough for those of us not heavily invested in interest rate futures.

I go with Larry because he lives closer to me than the Atlanta Fed.
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