Are inflation-protected Treasuries worth a look?

Dec 22, 2016
By BlackRock

Treasury Inflation Protected Securities are worth considering for your portfolio. Read how market dynamics are making TIPS more attractive.

Treasury Inflation Protected Securities (TIPS) are essentially Treasury issues that come with inflation protection. Like nominal Treasuries (those that are not inflation-adjusted), TIPS are issued by the U.S. government. Unlike nominal Treasuries, TIPS’s principal is linked to the Consumer Price Index (CPI). TIPS, which pay a fixed rate of interest twice per year, increase in value when inflation is on the rise, and decrease when inflation retreats.

We believe now may be a good time to consider TIPS, as certain policies of the incoming administration may lay the groundwork for more inflation, in particular infrastructure investment at the federal level and potential tax cuts that may boost consumer spending.

The relative performance of TIPS versus Treasuries also has been highly correlated to oil prices. This is partly because TIPS are indexed to the CPI, and energy prices play a key role in that reading. So, recent increases in oil prices have boosted expectations for CPI.

The recovery in oil prices from lows earlier this year reflects a balancing of supply and demand, and that appears to lessen the threat of large declines in oil prices, which is a key downside risk to the relative performance of TIPS.

— Jeffrey Rosenberg, BlackRock’s Chief Fixed Income Strategist.

The absolute short-term price performance of TIPS reflects mainly the outlook for real — i.e., inflation-adjusted — rates. With the Federal Reserve on a rate-hiking path (even if gradual), real rates will likely increase.

Oil prices and inflation expectations

Oil prices and inflation expectations

Source: Bloomberg, as of Nov. 9, 2016. Five-year TIPS reflects the five-year TIPS breakeven rate.

However, with rising inflation (and the potential for rising inflation expectations), we expect TIPS to outperform their nominal counterparts. As such, TIPS may be worth considering as an alternative to core Treasury allocations in fixed income portfolios.