U.S. Treasury Inflation Protected Securities (TIPS) ETF

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
#Cruncher
Posts: 3057
Joined: Fri May 14, 2010 2:33 am
Location: New York City
Contact:

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by #Cruncher »

jeffyscott wrote: Wed Jul 08, 2020 1:52 pmThere might be some confusion due to using the term "price", ...
Regarding TIPS there are two possible meanings for "price". Ambiguity about which meaning is intended probably leads to more confusion than any other aspect of TIPS.
  • "Unadjusted price" is how much you pay for each $100 of inflation-adjusted principal.
  • "Adjusted price" is how much you pay for each $100 of face value.
Adjusted price equals Unadjusted price multiplied by the "index ratio". This can be illustrated with yesterday's auction of 5-year TIPS maturing April 15, 2025. [*]

105.248398 = unadjusted price
0.99261 = index ratio 7/13/2020 (see this TD webpage)
104.470612 = adjusted price = 105.248398 * 0.99261


In this case a purchase of $1,000 face could be described as either I bought $992.61 of TIPS at an unadjusted price of 105.248398 or as I bought $1,000 of TIPS at an adjusted price of 104.470612. Either way I paid $1,044.71 (ignoring accrued interest). An analogy would be a 0.993 pound steak purchased at an (unadjusted) price of $10.52 per pound could also be described as one steak purchased at an (adjusted) price of $10.45 per steak. Either way I paid $10.45.

The unadjusted price is much more useful. (Because of this, that's what I'm referring to if I just use the unqualified term "price".) Here are a couple of ways it's more useful:
  • It allows TIPS prices and yields to be computed from each other the same way that prices and yields can be computed from each other for regular non-inflation-indexed bonds. On the contrary there is no way to compute a yield based on the adjusted price until a TIPS has either been sold on the secondary market or redeemed at maturity.
  • Two different TIPS can better be compared. For example, there are two TIPS that mature January 15, 2028 but were issued ten years apart. Since they have about the same yields, we can deduce that the 20-year TIPS has a higher (unadjusted) price because it has a higher coupon. Each (unadjusted) price can be determined mathematically from the TIPS' maturity, coupon, and yield. But no meaningful comparison can be made based on the adjusted price. [Yields and asked (unadjusted) prices are from Friday's WSJ TIPS Quotes and the index ratios are for 7/13/2020 from this webpage.]

    Code: Select all

                                                  Unadj     Index     Adj
                               Coupon   Yield     Price     Ratio    Price
                               ------  -------  ---------  -------  ------
    20-year TIPS issued 2008   1.750%  -0.844%  120.12500  1.22384  147.01
    10-year TIPS issued 2018   0.500%  -0.841%  110.40625  1.03943  114.76
* This is a strange TIPS auction unlike any I've ever seen. (But it still works fine for illustrating the two meanings for "price".) I suspect it took place to meet some technical Treasury requirement. I'd be interested to hear from anyone who knows its purpose.
  • It is for a tiny amount: only $25 million. The next smallest TIPS auctions I'm aware of were for about $5 billion.
  • It was in addition to the normal schedule. It's not listed on the Tentative Auction Schedule of U.S. Treasury Securities.
  • It wasn't announced until the day of the auction.
  • The TIPS will be issued 7/13/2020, the next business day after the auction.
  • There were no non-competitive bids.
Edited 7/12/2020 7:00 AM to add the following two items:
  • I received a private message from tipswatcher that the $25 million auction on Friday was the Treasury conducting a "live small-value contingency auction operation".
  • For those interested, here is one way that the (unadjusted) price can be computed from a TIPS yield. The simplest way would be to use the Excel PRICE function but unfortunately it doesn't work with negative yields. Here is an equivalent computation (that does work with negative yields) of the price of the two TIPS maturing January 15, 2028. It uses the Excel COUPDAYS, COUPDAYSNC, COUPNUM, and PV functions. (Note: "Dirty price" includes accrued interest; "Clean price" excludes it.)

    Code: Select all

    Row                  Col A       Col B     Col C   Formulas in column B
      1             Settlement  07/13/2020
      2               Maturity  01/15/2028
      3   Interest period days         182            =COUPDAYS(  B1,B2,2,1)
      4  Days after settlement           2            =COUPDAYSNC(B1,B2,2,1)
      5   Number interest pmts          16            =COUPNUM(   B1,B2,2,1)
      6                 Coupon      1.750%    0.500% 
      7      Yield to maturity     (0.844%)  (0.841%)
      8            Dirty price     121.008   110.659  =100*(-PV(B7/2,$B5-1,B6/2,1,0)+B6/2)/(1+B7/2)^($B4/$B3)
      9       Accrued interest       0.865     0.247  =100*(B6/2)*(1-$B4/$B3)
     10            Clean price     120.143   110.412  =B8-B9
Robot Monster
Posts: 1539
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Robot Monster »

#Cruncher wrote: Sat Jul 11, 2020 2:29 pm An analogy would be a 0.993 pound steak purchased at an (unadjusted) price of $10.52 per pound could also be described as one steak purchased at an (adjusted) price of $10.45 per steak. Either way I paid $10.45.
See, I would have said the price is the amount of money I have to pull out of my wallet i.e. the $10.45. (Goes to show how much of a chucklehead I am!) In the case of buying TIPS, I'm talking about the amount of money I have to cough up to complete the transaction, and after that, I'm talking about the dollar amount that my Vanguard statement shows.

That's the number I'm interested in.

What happens to that number when interests rates change, when inflation changes, when expected inflation changes, etc...could there not be a Understanding TIPS Prices for Dummies that could answer questions like this without having to get into the unadjusted/adjusted stuff? Some of us were in the slow class. Have pity.
"Happiness comes from being connected in the right ways to: other people, your work, something larger than yourself."
User avatar
#Cruncher
Posts: 3057
Joined: Fri May 14, 2010 2:33 am
Location: New York City
Contact:

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by #Cruncher »

Robot Monster wrote: Sun Jul 12, 2020 9:30 am... and after [purchasing TIPS], I'm talking about the dollar amount that my Vanguard statement shows. That's the number I'm interested in.
The whole point about TIPS is not having to be interested in their dollar value reported on your brokerage statement. One buys TIPS to provide a known constant dollar amount in the future. So I don't care whether their value is shown as $10,000 with no change in the CPI or as $12,000 after the CPI has risen 20%. [1] In both cases my purchasing power is the same -- and that's what I'm interested in.
Robot Monster, continuing, wrote:What happens to that number when interests rates change, when inflation changes, when expected inflation changes, etc. (underlines added)
By "that number" you're referring to the adjusted price which is the product of the unadjusted price and the index ratio. Knowing this we can lay out the effect of the three changes you mention. (I'll show the results if the three things increase. "Down" and "Up" would reverse for a decrease.)

Code: Select all

                     ----------- Results In ---------- 
                     Unadjusted    Index      Adjusted
  Increase In           Price   X  Ratio   =    Price
------------------   ----------    ------     --------
interests rates         Down       No Chg       Down  [2]
inflation              No Chg        Up          Up
expected inflation     No Chg      No Chg      No Chg [3]
Robot Monster, continuing, wrote:... could there not be a Understanding TIPS Prices for Dummies that could answer questions like this without having to get into the unadjusted/adjusted stuff?
It's not for dummies, but the best book explaining TIPS I know is Explore TIPS by board member tfb. The author also has this web site with some of the information from the book. I also suggest searching for posts (such as this one) by board member nisiprius (he's a much better writer than I) with the keywords "TIPS" "denominated" and "constant".

I don't know how to explain the issue, Robot Monster, without distinguishing between the concepts of "unadjusted" and "adjusted" prices. Maybe the words are confusing. I chose them simply to conform with the wording used by the Treasury in its auction results. I tried making the concepts clearer with the price of a steak analogy. That's about the best I can do without repeating myself.
  1. This is for a tax free or tax deferred account. In a taxable account, I'd prefer the $10,000 case with no increase in the CPI to maximize my after tax purchasing power.
  2. By "interest rates" I mean TIPS interest rates.
  3. Expected inflation changing has no effect on TIPS prices. The effect would be on nominal bonds. E.g., if expected inflation rose, nominal bond yields would rise, and their prices fall.
Angst
Posts: 2435
Joined: Sat Jun 09, 2007 11:31 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Angst »

#Cruncher wrote: Sat Jul 11, 2020 2:29 pm * This is a strange TIPS auction unlike any I've ever seen. (But it still works fine for illustrating the two meanings for "price".) I suspect it took place to meet some technical Treasury requirement. I'd be interested to hear from anyone who knows its purpose.
  • It is for a tiny amount: only $25 million. The next smallest TIPS auctions I'm aware of were for about $5 billion.
  • It was in addition to the normal schedule. It's not listed on the Tentative Auction Schedule of U.S. Treasury Securities.
  • It wasn't announced until the day of the auction.
  • The TIPS will be issued 7/13/2020, the next business day after the auction.
  • There were no non-competitive bids.
Edited 7/12/2020 7:00 AM to add the following two items:
On May 6th Treasury gave us something of a heads up at the end of a routine press release with the following:
Treasury Dept. wrote:Small-Value Contingency Auction Operation Test

Treasury believes that it is prudent to regularly test its contingency auction infrastructure. Treasury’s contingency auction system has been used routinely over the last several years to conduct both mock auctions and live small-value test auctions. Sometime over the next three months, Treasury intends to conduct a small-value test auction using its contingency auction system. Details about this test will be announced at a later date.

This small-value test auction should not be viewed by market participants as a precursor or signal of any pending policy changes regarding Treasury’s existing auction processes.
But I couldn't find any clues ahead of time as to what kind of treasury security was going to be "tested". It looks like they've been holding these once a year or so on average for the last few years, but this must be the first one using TIPS:
https://www.google.com/search?sitesearch=treasurydirect.gov&q=LIVE+SMALL-VALUE+CONTINGENCY+AUCTION
Robot Monster
Posts: 1539
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Robot Monster »

#Cruncher wrote: Sun Jul 12, 2020 5:02 pm

Code: Select all

                     ----------- Results In ---------- 
                     Unadjusted    Index      Adjusted
  Increase In           Price   X  Ratio   =    Price
------------------   ----------    ------     --------
interests rates         Down       No Chg       Down  [2]
inflation              No Chg        Up          Up
expected inflation     No Chg      No Chg      No Chg [3]
I mostly care about the adjusted price as seen on my brokerage statement, because I own both the Vanguard TIPS fund and 5-yr TIPS bonds, and see that their daily reported prices move in unison, and I figured if I could understand the price movements in TIPS bonds, I'd be able to understand the movements in the fund.

I find the above helpful, but surprising, as far as the expected inflation behavior. If I'm understanding the above correctly, the adjusted price will increase if inflation increases. Let's say I buy a 5-year TIPS when inflation is 1%, and the 5-year expected inflation is also 1%. The very next day, 5-year expected inflation changes to 2%. Now, you're saying the adjusted price (what I see in my brokerage account) does not change. This is bizarre to me. Shouldn't the market be pricing in a change of the real inflation to 2% over the next five years? Because if the expected inflation of 2% is proven right, the adjusted price will increase, if I'm indeed understanding it correctly that the adjusted price will increase if inflation increases.

Maybe I'm making a muddle of this and should just go read the book you kindly recommended.
"Happiness comes from being connected in the right ways to: other people, your work, something larger than yourself."
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by hudson »

#Cruncher wrote: Sun Jul 12, 2020 5:02 pm but the best book explaining TIPS I know is Explore TIPS by board member tfb.
Thanks #Cruncher! I bought the PDF version directly for $7.95 and immediately downloaded it.
User avatar
Mel Lindauer
Moderator
Posts: 31130
Joined: Mon Feb 19, 2007 8:49 pm
Location: Daytona Beach Shores, Florida
Contact:

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Mel Lindauer »

I haven't read every post in full, but glancing through them all, I'm surprised that no one has mentioned I Bonds when the discussion turned to protection against both INflation and DEflation.

Since the I Bond composite rate can never go below 0%, the greater the rate of DEflation, the higher the REAL return on the I Bonds. And they move up with inflation, so you're covered there, too.
Best Regards - Mel | | Semper Fi
Always passive
Posts: 670
Joined: Fri Apr 14, 2017 4:25 am
Location: Israel

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Always passive »

As I retiree, a major part of my income comes from a TIPS ladder as bonds mature. Thus, I have been buying TIPS annually to always keep a 10 year ladder in front of me. This year I have not done so, keeping the money in the Total Bond Market (AGG). Maybe I am wrong, but I cannot get myself to buy a 10 year TIPS bond with negative real return. It seems to me that from the start I am losing money in real terms. Am i wrong? What to do?
mmortal03
Posts: 8
Joined: Sun Dec 04, 2016 7:01 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by mmortal03 »

Mel Lindauer wrote: Tue Jul 14, 2020 12:48 am I haven't read every post in full, but glancing through them all, I'm surprised that no one has mentioned I Bonds when the discussion turned to protection against both INflation and DEflation.

Since the I Bond composite rate can never go below 0%, the greater the rate of DEflation, the higher the REAL return on the I Bonds. And they move up with inflation, so you're covered there, too.
Interesting. Here's the bogleheads wiki comparison: https://www.bogleheads.org/wiki/I_Bonds_vs_TIPS
User avatar
jeffyscott
Posts: 9151
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by jeffyscott »

Always passive wrote: Tue Jul 14, 2020 1:03 amMaybe I am wrong, but I cannot get myself to buy a 10 year TIPS bond with negative real return. It seems to me that from the start I am losing money in real terms. Am i wrong? What to do?
It's not just that they are negative, but they are at about -0.8%. That means a guaranteed real loss of 8% over 10 years. I'm phasing out of TIPS at these rates, but also do not like nominal treasuries at the current yields and so don't want the bond index either. I'd rather take some risk or deal with the hassle of moving to CDs.

I had resisted moving IRA money to direct CDs after brokered CDs yields became unappealing, but just did my first one at 1.9% for 3 years. The money came partly from TIPS and partly from brokered CDs that had matured.

We are retired, but our modest normal expenses of less than $3000 per month are met by pensions.
The two greatest enemies of the equity fund investor are expenses and emotions. ― John C. Bogle
Robot Monster
Posts: 1539
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Robot Monster »

Mel Lindauer wrote: Tue Jul 14, 2020 12:48 am I haven't read every post in full, but glancing through them all, I'm surprised that no one has mentioned I Bonds when the discussion turned to protection against both INflation and DEflation.

Since the I Bond composite rate can never go below 0%, the greater the rate of DEflation, the higher the REAL return on the I Bonds. And they move up with inflation, so you're covered there, too.
Yep. It's true. We do tend to forget about them around here. Appreciate the reminder.
"Happiness comes from being connected in the right ways to: other people, your work, something larger than yourself."
Coltrane75
Posts: 199
Joined: Wed Feb 06, 2019 2:32 pm

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Coltrane75 »

Looks like June CPI report shows inflation bouncing back.

Things look pretty good for anyone who loaded up on TIPS or I Bonds over the past couple of months.

We may look back on March/April 2020 as a big buying opportunity based on a big over-reaction.
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by hudson »

jeffyscott wrote: Tue Jul 14, 2020 8:25 am
It's not just that they are negative, but they are at about -0.8%. That means a guaranteed real loss of 8% over 10 years.

I'd rather take some risk or deal with the hassle of moving to CDs.

I had resisted moving IRA money to direct CDs after brokered CDs yields became unappealing, but just did my first one at 1.9% for 3 years.
CDs, even with low rates, look very attractive compared to other alternatives.
TIPs don't look attractive, but might be the right choice? or not? Nobody knows!
Robot Monster
Posts: 1539
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Robot Monster »

Coltrane75 wrote: Tue Jul 14, 2020 8:55 am Looks like June CPI report shows inflation bouncing back.
Yep, and here are the numbers...

"Annual core CPI remains steady at 1.2% in June vs. 1.1% expected"
https://www.fxstreet.com/news/us-annual ... 2007141237

The 5-Year Breakeven Inflation Rate is 1.27%. The 5-yr TIPS is -1.02%.
"Happiness comes from being connected in the right ways to: other people, your work, something larger than yourself."
User avatar
jeffyscott
Posts: 9151
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by jeffyscott »

Robot Monster wrote: Tue Jul 14, 2020 9:26 am
Coltrane75 wrote: Tue Jul 14, 2020 8:55 am Looks like June CPI report shows inflation bouncing back.
Yep, and here are the numbers...

"Annual core CPI remains steady at 1.2% in June vs. 1.1% expected"
https://www.fxstreet.com/news/us-annual ... 2007141237

The 5-Year Breakeven Inflation Rate is 1.27%. The 5-yr TIPS is -1.02%.
TIPS do not adjust based on core CPI. What they do use, the NSA CPI-U, was up 0.5% for June and 0.6% for the past 12 months.
The two greatest enemies of the equity fund investor are expenses and emotions. ― John C. Bogle
Robot Monster
Posts: 1539
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Robot Monster »

jeffyscott wrote: Tue Jul 14, 2020 9:36 am
Robot Monster wrote: Tue Jul 14, 2020 9:26 am
Coltrane75 wrote: Tue Jul 14, 2020 8:55 am Looks like June CPI report shows inflation bouncing back.
Yep, and here are the numbers...

"Annual core CPI remains steady at 1.2% in June vs. 1.1% expected"
https://www.fxstreet.com/news/us-annual ... 2007141237

The 5-Year Breakeven Inflation Rate is 1.27%. The 5-yr TIPS is -1.02%.
TIPS do not adjust based on core CPI. What they do use, the NSA CPI-U, was up 0.5% for June and 0.6% for the past 12 months.
Appreciate that. So, I find that information in,
https://www.bls.gov/cpi/latest-numbers.htm

Are those number what they appear to be, i.e scarily low??
"Happiness comes from being connected in the right ways to: other people, your work, something larger than yourself."
User avatar
jason2459
Posts: 613
Joined: Wed May 06, 2020 7:59 pm

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by jason2459 »

Robot Monster wrote: Tue Jul 14, 2020 9:46 am
jeffyscott wrote: Tue Jul 14, 2020 9:36 am
Robot Monster wrote: Tue Jul 14, 2020 9:26 am
Coltrane75 wrote: Tue Jul 14, 2020 8:55 am Looks like June CPI report shows inflation bouncing back.
Yep, and here are the numbers...

"Annual core CPI remains steady at 1.2% in June vs. 1.1% expected"
https://www.fxstreet.com/news/us-annual ... 2007141237

The 5-Year Breakeven Inflation Rate is 1.27%. The 5-yr TIPS is -1.02%.
TIPS do not adjust based on core CPI. What they do use, the NSA CPI-U, was up 0.5% for June and 0.6% for the past 12 months.
Appreciate that. So, I find that information in,
https://www.bls.gov/cpi/latest-numbers.htm

Are those number what they appear to be, i.e scarily low??
Looks good to me. Highest June number in past 10 years. :happy
User avatar
jeffyscott
Posts: 9151
Joined: Tue Feb 27, 2007 9:12 am
Location: Wisconsin

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by jeffyscott »

jason2459 wrote: Tue Jul 14, 2020 9:59 am
Robot Monster wrote: Tue Jul 14, 2020 9:46 am
jeffyscott wrote: Tue Jul 14, 2020 9:36 am
Robot Monster wrote: Tue Jul 14, 2020 9:26 am
Coltrane75 wrote: Tue Jul 14, 2020 8:55 am Looks like June CPI report shows inflation bouncing back.
Yep, and here are the numbers...

"Annual core CPI remains steady at 1.2% in June vs. 1.1% expected"
https://www.fxstreet.com/news/us-annual ... 2007141237

The 5-Year Breakeven Inflation Rate is 1.27%. The 5-yr TIPS is -1.02%.
TIPS do not adjust based on core CPI. What they do use, the NSA CPI-U, was up 0.5% for June and 0.6% for the past 12 months.
Appreciate that. So, I find that information in,
https://www.bls.gov/cpi/latest-numbers.htm

Are those number what they appear to be, i.e scarily low??
Looks good to me. Highest June number in past 10 years. :happy
Yes, +0.5% in one month is not low. Average June over the previous 10 was 0.2% for June, highest being 0.9% in June 2009 and second was 0.4% in June 2015.

Of course, the 0.6% for 12 months is very low.
The two greatest enemies of the equity fund investor are expenses and emotions. ― John C. Bogle
dbr
Posts: 33842
Joined: Sun Mar 04, 2007 9:50 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by dbr »

Economists looking at systems such as the US economy have considered 2%-3% inflation to be normal and desirable. Below 1% is very low both historically and by conventional thinking.

I am not sure what the concern in this thread about low inflation might be. Maybe someone can explain.
Robot Monster
Posts: 1539
Joined: Sun May 05, 2019 11:23 am
Location: New York

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Robot Monster »

dbr wrote: Tue Jul 14, 2020 10:40 am Economists looking at systems such as the US economy have considered 2%-3% inflation to be normal and desirable. Below 1% is very low both historically and by conventional thinking.

I am not sure what the concern in this thread about low inflation might be. Maybe someone can explain.
Might be rather like concern that if my house doesn't burn down, I'm not gonna get a return on investment for my fire insurance.

Or perhaps there is no concern, and in reality we are just amusing ourselves between one thing and the other. Who's up for another Margarita?
"Happiness comes from being connected in the right ways to: other people, your work, something larger than yourself."
Valuethinker
Posts: 41166
Joined: Fri May 11, 2007 11:07 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by Valuethinker »

dbr wrote: Tue Jul 14, 2020 10:40 am Economists looking at systems such as the US economy have considered 2%-3% inflation to be normal and desirable. Below 1% is very low both historically and by conventional thinking.

I am not sure what the concern in this thread about low inflation might be. Maybe someone can explain.
Wages are sticky at the zero lower bound.

Meaning that for example even with Spain which had one of the worst financial crises of any nations, rather than wages falling they stuck at 0 change. Unemployment rise over 20 per cent and half of those under 25 not in full time education were unemployed. The Spanish economy went into a deep freeze.

This is like putting a price floor in a market. Since wages cannot be cut so that supply of labour equals demand, you get too much labour and not enough demand from employers. And thus you get far more unemployment.

In a recession rather than us all taking a 10 per cent pay cut for example, 10% of us lose our jobs.

The knock on effect of this is that *everyone* gets scared of losing their jobs, and cuts back spending. Thus producing a stable situation where lots of people are unemployed and the economy doesn't grow or doesn't grow enough to reduce unemployment. Businesses are afraid to invest and to hire people etc.

Besides Spain another example would be Canada's zero inflation rate policy in the early 1990s. Canada endured the worst recession of the postwar period while the US economy was recovering, with double digit unemployment rates. Toronto had a 14 year housing price slump.

So because labour markets don't smoothly clear in the way theory predicts, empirically you have these huge costs to very low inflation or deflation.

(Theres actually a similar story on prices generally. Companies would often rather sell less than actually cut prices. You see this more with restaurants say than cars or appliances. So it is not quite as general a story).

Central Bankers and economists have learned from these experiences and have tended to target inflation rates which are low but not too low.

That way if a macroeconomic shock causes a sharp fall in prices, inflation is unlikely to go below zero. Because the costs on lost output and inflation of outright deflation really can be grievous.

The world, with the current pandemic, is nicely set for a deflationary shock. Cash balances are at record highs. Consumers just aren't going to spend if they are afraid of going out, and if everyone is worried about losing their jobs.

We shall see if the various inflationary measures adopted by governments and Central Banks stem this. It is really not clear (,to me) which way it will go.
User avatar
#Cruncher
Posts: 3057
Joined: Fri May 14, 2010 2:33 am
Location: New York City
Contact:

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by #Cruncher »

Robot Monster wrote: Mon Jul 13, 2020 11:13 amLet's say I buy a 5-year TIPS when inflation is 1%, and the 5-year expected inflation is also 1%. The very next day, 5-year expected inflation changes to 2%. Now, you're saying the adjusted price (what I see in my brokerage account) does not change. This is bizarre to me. Shouldn't the market be pricing in a change of the real inflation to 2% over the next five years? Because if the expected inflation of 2% is proven right, the adjusted price will increase, ... (underline added)
Yes, the adjusted price will increase. But not today; not all at once. It will increase gradually over the next five years. Here is what would happen for the following hypothetical case:
  • You buy the TIPS at the initial auction at an unadjusted price of 100 when its index ratio is 1.
  • TIPS yields are the same for all maturities up to 5 years and don't change.
  • The CPI rises at a constant 2% each year.

Code: Select all

      Unadj    Index      Adj
Year  Price    Ratio     Price
----  -----   -------   -------
   0    100   1.00000   100.000
   1    100   1.02000   102.000
   2    100   1.04040   104.040
   3    100   1.06121   106.121
   4    100   1.08243   108.243
   5    100   1.10408   110.408
What will change today, all at once, is the price of 5-year nominal Treasury bonds. Other things being equal, their yields will jump 1% point and their prices correspondingly fall about 5%.
User avatar
FIREchief
Posts: 5334
Joined: Fri Aug 19, 2016 6:40 pm

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by FIREchief »

Always passive wrote: Tue Jul 14, 2020 1:03 am Maybe I am wrong, but I cannot get myself to buy a 10 year TIPS bond with negative real return. It seems to me that from the start I am losing money in real terms. Am i wrong? What to do?
You're not wrong. That said, with a TIPS purchase you know exactly how much purchasing power you're going to lose over those ten years. With any other safe fixed income investment, you don't know. It's very possible that most will have negative real yields, and also possible that TIPS will outperform the rest if inflation during those ten years exceeds current expectations. Nobody knows.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.
mmortal03
Posts: 8
Joined: Sun Dec 04, 2016 7:01 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by mmortal03 »

dbr wrote: Sat Apr 18, 2020 11:23 am
Blueskies123 wrote: Sat Apr 18, 2020 11:14 am
Will you explain how TIPS provide protection from expected inflation? Or to be more precise, how TIPS provide protection from expected inflation any better than non-TIPS bonds (because expected inflation is already priced into all bonds)?
This is a point of great confusions. Obviously if expected inflation is priced into nominal bonds then both kinds of bonds have no expected inflation risk. That includes that the statement that short TIPS have no inflation risk expected or unexpected is true. It is also true that to the extent nominal bonds are properly priced with respect to expected inflation that there would be no advantage regarding this risk to own TIPS. I am not sure I understand what reason one would have to own short TIPS other than that one can be certain the inflation adjustment is there.
How persistent are people imagining, or *expecting*, such a period of... *unexpected* inflation to go on for before the market finally prices the new inflation conditions/trend into the nominal bonds, though? In other words, if the market supposedly accounts for expected inflation in both nominal bonds and TIPS, but unexpected inflation arises, wouldn't the nominal bond market also start to react to this circumstance, it might just take a little more time?
dbr
Posts: 33842
Joined: Sun Mar 04, 2007 9:50 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by dbr »

Valuethinker wrote: Tue Jul 14, 2020 3:29 pm
dbr wrote: Tue Jul 14, 2020 10:40 am Economists looking at systems such as the US economy have considered 2%-3% inflation to be normal and desirable. Below 1% is very low both historically and by conventional thinking.

----snip----
Thank you. I appreciate this reply, which I think is an excellent description of what I imagined the issue might be from the point of view of economic well being.
mmortal03 wrote: Tue Jul 14, 2020 4:39 pm
dbr wrote: Sat Apr 18, 2020 11:23 am
Blueskies123 wrote: Sat Apr 18, 2020 11:14 am
Will you explain how TIPS provide protection from expected inflation? Or to be more precise, how TIPS provide protection from expected inflation any better than non-TIPS bonds (because expected inflation is already priced into all bonds)?
This is a point of great confusions. Obviously if expected inflation is priced into nominal bonds then both kinds of bonds have no expected inflation risk. That includes that the statement that short TIPS have no inflation risk expected or unexpected is true. It is also true that to the extent nominal bonds are properly priced with respect to expected inflation that there would be no advantage regarding this risk to own TIPS. I am not sure I understand what reason one would have to own short TIPS other than that one can be certain the inflation adjustment is there.
How persistent are people imagining, or *expecting*, such a period of... *unexpected* inflation to go on for before the market finally prices the new inflation conditions/trend into the nominal bonds, though? In other words, if the market supposedly accounts for expected inflation in both nominal bonds and TIPS, but unexpected inflation arises, wouldn't the nominal bond market also start to react to this circumstance, it might just take a little more time?
I think the answer to that scenario is that the process of pricing in means that nominal interest rates go up but real interest rates do not. That means the price of existing nominal bonds falls, which is bad, but the price of TIPS, after allowing for inflation increment, still does not fall, which is good. A different problem is that if inflation increases real rates might also increase and there would be some loss of return to TIPS.

Remember that when you buy a bond, the coupon is set. The fact that later on inflation gets priced in does not help you and the bond you already own. If you buy a TIPS the real coupon is set, but the contract to increment for inflation does help you as time goes on.
mmortal03
Posts: 8
Joined: Sun Dec 04, 2016 7:01 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by mmortal03 »

dbr wrote: Tue Jul 14, 2020 8:25 pm
mmortal03 wrote: Tue Jul 14, 2020 4:39 pm How persistent are people imagining, or *expecting*, such a period of... *unexpected* inflation to go on for before the market finally prices the new inflation conditions/trend into the nominal bonds, though? In other words, if the market supposedly accounts for expected inflation in both nominal bonds and TIPS, but unexpected inflation arises, wouldn't the nominal bond market also start to react to this circumstance, it might just take a little more time?
I think the answer to that scenario is that the process of pricing in means that nominal interest rates go up but real interest rates do not. That means the price of existing nominal bonds falls, which is bad, but the price of TIPS, after allowing for inflation increment, still does not fall, which is good. A different problem is that if inflation increases real rates might also increase and there would be some loss of return to TIPS.

Remember that when you buy a bond, the coupon is set. The fact that later on inflation gets priced in does not help you and the bond you already own. If you buy a TIPS the real coupon is set, but the contract to increment for inflation does help you as time goes on.
Thanks, that's helpful, but how might this perspective change if the comparison is, instead, between nominal and inflation adjusted bond *funds*, where new bonds are being purchased regularly, such that the average coupon yield on even the nominal bonds in a fund will change over time?
dbr
Posts: 33842
Joined: Sun Mar 04, 2007 9:50 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by dbr »

mmortal03 wrote: Wed Jul 15, 2020 1:10 pm
dbr wrote: Tue Jul 14, 2020 8:25 pm
mmortal03 wrote: Tue Jul 14, 2020 4:39 pm How persistent are people imagining, or *expecting*, such a period of... *unexpected* inflation to go on for before the market finally prices the new inflation conditions/trend into the nominal bonds, though? In other words, if the market supposedly accounts for expected inflation in both nominal bonds and TIPS, but unexpected inflation arises, wouldn't the nominal bond market also start to react to this circumstance, it might just take a little more time?
I think the answer to that scenario is that the process of pricing in means that nominal interest rates go up but real interest rates do not. That means the price of existing nominal bonds falls, which is bad, but the price of TIPS, after allowing for inflation increment, still does not fall, which is good. A different problem is that if inflation increases real rates might also increase and there would be some loss of return to TIPS.

Remember that when you buy a bond, the coupon is set. The fact that later on inflation gets priced in does not help you and the bond you already own. If you buy a TIPS the real coupon is set, but the contract to increment for inflation does help you as time goes on.
Thanks, that's helpful, but how might this perspective change if the comparison is, instead, between nominal and inflation adjusted bond *funds*, where new bonds are being purchased regularly, such that the average coupon yield on even the nominal bonds in a fund will change over time?
That question is above my pay grade. I wish one of the real gurus on bonds might respond.

But I would think since a fund is a holding of a bunch of individual bonds one would have to track the effect bond by bond and add it up, keeping tally of how the fund composition changes over time and keeping track of the time evolution of expected and unexpected inflation. I would have no idea were to get the data to do that. A person might construct arbitrary hypothetical examples. Of course the TIPS fund would behave as expected.
User avatar
vineviz
Posts: 7845
Joined: Tue May 15, 2018 1:55 pm

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by vineviz »

mmortal03 wrote: Wed Jul 15, 2020 1:10 pm Thanks, that's helpful, but how might this perspective change if the comparison is, instead, between nominal and inflation adjusted bond *funds*, where new bonds are being purchased regularly, such that the average coupon yield on even the nominal bonds in a fund will change over time?
The return of a nominal bond fund is always going deviate from a TIPS fund by (conceptually) the cumulative difference between actual inflation and expected inflation.

It's true that changes in inflation expectations do tend to lead to changes in nominal yields, but the relationship isn't 1:1. And if your time horizon is different from the duration of the bond fund, there's no guarantee the change in coupon reinvestment rate will match the offsetting change in bond price.

It's not at all uncommon for nominal bond funds to have negative real returns for periods of ten years or more if inflation expectations are consistently being lowered. Of course the opposite can be true too, so it's wise to match the type (nominal/inflation-linked) and duration of your bond fund to your expected expenses if you want to avoid surprises.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
dbr
Posts: 33842
Joined: Sun Mar 04, 2007 9:50 am

Re: U.S. Treasury Inflation Protected Securities (TIPS) ETF

Post by dbr »

vineviz wrote: Wed Jul 15, 2020 2:09 pm

. . . . The return of a nominal bond fund is always going deviate from a TIPS fund by (conceptually) the cumulative difference between actual inflation and expected inflation. . . .

Thanks for the reply.
Post Reply