TIPs in the future and "flight to safety"

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newbie001
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TIPs in the future and "flight to safety"

Post by newbie001 »

The recent thread discussing a possible asymmetry in the risks of nominal Treasuries and TIPS got me thinking about something that has bothered me for a while. For a risk-averse investor, it is nice to have a meaningful allocation to Treasuries, especially long term Treasuries, as they have been (and presumably still are for now) the premier "flight to safety" asset during market disasters. Of course, holding long term Treasuries exposes the holder to, among other things, serious inflation risk. If TIPS offered the same safe haven status that LTTs do, I would probably opt to hold them rather than LTTs.

I know the performance of TIPS during the 2008 meltdown has been discussed here many times, with many positing that their disappointing performance then reflected their lesser liquidity relative to LTTs, or perhaps fears of impending deflation. I also know that Larry Swedroe opined at least a couple of times that this problem would probably disappear once the TIPS market became deeper and more liquid. I see that the market for TIPS has since grown in popularity but it still lags that for Treasuries, even just LTTs:

https://www.treasurydirect.gov/govt/cha ... l_debt.htm

My first question is: given the current status of the TIPs market, is it realistic to expect TIPS to act as a safe haven asset in the future, to the extent they are comparable to nominal Treasuries in that respect? Perhaps the answer depends on whether the given crisis has deflationary or inflationary implications?

My second question is: if you believe that TIPS will be comparable to nominal treasuries as a safe haven asset in the future, would long-term TIPS make the most sense?

Thanks in advance for all replies- I appreciate the extraordinary wisdom of this community.
alluringreality
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Re: TIPs in the future and "flight to safety"

Post by alluringreality »

newbie001 wrote: Thu Sep 22, 2022 12:37 pm My first question is: given the current status of the TIPs market, is it realistic to expect TIPS to act as a safe haven asset in the future, to the extent they are comparable to nominal Treasuries in that respect? Perhaps the answer depends on whether the given crisis has deflationary or inflationary implications?
I'll suggest that in a disinflationary or deflationary event a fixed payment rate (nominal bonds) might fundamentally be worth more than a stream of payments and a final value that depends on CPI-U changes (TIPS). Functionally, I'm not sure that the "comparable to nominal Treasuries" idea would necessarily apply during the sorts of events that often are labeled "flight to safety". Recent events suggest that an inflationary environment may likewise not drive up the immediate value for TIPS duration, so limited duration might be preferable in a potential rising rate environment, unless expectations are for the rise in rates to come in lower than projected inflation. Honestly I'm simply not following why TIPS duration might necessarily benefit immediate value in either an inflationary or deflationary event, while considering how monetary policy has recently dealt with such environments. I can't say that overall I understand why some, presumably long-term investors, seem to overwhelmingly prefer long-duration nominals to long-duration TIPS, since the historical average performance doesn't look too drastically different to me, even presuming rebalancing during deflationary events. Essentially I'm not connecting the dots on the line of thought here, but I'm interested to see if there's any discussion around the topic. There was a fairly recent thread on the topic of "Flight To Safety", although it didn't include the focus on TIPS duration.
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vineviz
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Re: TIPs in the future and "flight to safety"

Post by vineviz »

newbie001 wrote: Thu Sep 22, 2022 12:37 pm My second question is: if you believe that TIPS will be comparable to nominal treasuries as a safe haven asset in the future, would long-term TIPS make the most sense?=
What makes the most sense, IMHO, is choosing TIPS with a duration that matches your expected investment horizon.

That removes any worries about liquidity almost completely.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Jayhawker
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Re: TIPs in the future and "flight to safety"

Post by Jayhawker »

Breakeven inflation rates decreased dramatically during the two liquidity crises TIPS have been around for.[1] I'm not aware of any way to tell how much of that was driven by genuine updating of inflation expectations versus the "flight to safety" effect driving nominal Treasury yields down.

Personally I find it hard to believe the market truly expected sub-1% annualized inflation over a 10 year period in 2008 and 2020 so I chalk a lot of it up to "flight to safety." That guess is worth what you paid for it, of course. I wouldn't want to bet anything on TIPS being as liquid (and benefiting from flight to safety) as Treasuries for the first time during a crisis during the next crisis.

All that said... for me matching bonds to future liabilities is the overriding factor in my choices versus liquidity. I don't have a mortgage and thus don't have any liabilities beyond 1 year that are fixed in nominal terms. I'd be taking unnecessary inflation risk with nominal bonds to match real liabilities. So the vast majority of my fixed income is in TIPS and I-Bonds.

[1]: https://fred.stlouisfed.org/graph/?g=U0pq
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squirrel1963
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Re: TIPs in the future and "flight to safety"

Post by squirrel1963 »

Are you worried about TIPS being less liquid, or are you worried about interest rate risk? You can eliminate both by buying individual TIPS for the time horizon you want and hold them to maturity.
| LMP | safe portfolio: TIPS ladder + I-bonds + Treasuries | risky portfolio: US stocks / US REIT / International stocks |
BigJohn
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Re: TIPs in the future and "flight to safety"

Post by BigJohn »

The TIPS liquidity issue was pretty short lived. They bounced back within a few months IIRC. Those that were disappointed were looking to rebalance quickly while stocks were way down. In my mind this doesn’t make TIPS less safe but you do need to understand and accept the potential that it could happen again. Only you can decide if this is a big enough deal to sway your decision.
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