Treasury Inflation-Protected Securities, or TIPS, can help protect against inflation over the long run, but in the short term their performance may be dictated more by price declines in the secondary market. That's been the case so far this year.
Inflation has risen at its fastest rate in decades, but Treasury Inflation-Protected Securities are still down sharply this year. What gives?
Treasury Inflation-Protected Securities, or TIPS, can help protect against inflation over the long-run, but over the short run, their performance may be dictated more by price declines in the secondary market than by the inflation-driven principal adjustment. That's been the case so far this year.
When considering TIPS, it's important to understand their unique characteristics and complex nature. Below we'll discuss what drove the performance this year, and what investors can expect going forward. While the start of the year has been forgettable for TIPS investors, yields are now back in positive territory, and TIPS can help play an important role in protecting your portfolio from inflation over the long run.
TIPS: the basics
TIPS are a type of Treasury security whose principal value is indexed to inflation. As the level of the Consumer Price Index (CPI) rises and falls, so too does the value of a TIPS. Like traditional Treasury securities, TIPS have fixed coupon rates based off of the principal value—so coupon payments rise or fall with the level of the CPI as the principal value fluctuates.
This characteristic helps TIPS protect investors against the effects of inflation, because they'll be rewarded with a higher principal value at maturity as well as growing coupon payments if inflation is rising. (Traditional Treasuries simply mature at their $1,000 par value.) The opposite is true as well: In deflationary periods, the principal value of a TIPS will fall, resulting in smaller coupon payments. At maturity, however, a TIPS investor would receive either the adjusted higher principal or the original principal value. In other words, TIPS never pay back less than the initial principal value at maturity.
High inflation, negative returns
TIPS returns are in the red this year as price declines have more than offset the inflation adjustment to TIPS principal values. While they've outperformed traditional Treasuries, the Bloomberg U.S. Treasury Inflation-Protected Notes Index is still down sharply this year and is off to its worst start to a year1 since its inception in 1997. That's likely caught many investors off guard, considering the Consumer Price Index rose by more than 8% in the twelve months ending April 2022.