TIPS Update: 30-Year TIPS Now Available
Our last update on the TIPS market was Jan. 15, so I thought it worthwhile to provide an update. (I'll try to do these each month.)
On Monday, the Treasury auctioned 30-year TIPS for the first time since 2001. This is a positive development, providing you with the opportunity to extend maturities if you wish.
The new 30-year TIPS with a yield of 2.17 (as of Monday) is attractive relative to the 30-year nominal issue with its yield of 4.63. That's a break-even inflation rate of 2.5 percent. Given that the inflation estimate from the Philadelphia Federal Reserve is 2.4 percent over the next 10 years, you're paying a risk premium of only 0.1 percent to eliminate the risk of unexpected inflation. That seems quite reasonable.
On the other hand, the current yield is below the long-term average real yield of both nominal bonds and 20-year TIPS. Thus, it seems prudent to limit maturities to about 15 years, the current sweet spot (see below). If real rates rise well above the historical averages, you should consider locking in the higher yields for as long as possible. Higher TIPS yields would provide the added benefit of allowing you to lower your equity allocation, thereby reducing the risk of the overall portfolio without lowering expected returns.
Current and Historical Data
The first table provides the historical data on the real return of nominal bonds from 1926 through 2009. The second table shows both the mean TIPS yield and the percentage of time since 1997 that the TIPS yield has been above the mean.
|
Historical Returns (%) |
|||||
|
Five Years |
10 Years |
20 Years |
|||
|
Nominal |
Real |
Nominal |
Real |
Nominal |
Real |
|
5.32 |
2.24 |
5.36 |
2.28 |
5.44 |
2.35 |
|
Current Yields and Mean Yield (%) |
|||
|
Five Years |
10 Years |
20 Years |
|
| Mean Yield |
2.26 |
2.69 |
2.19** |
| Current Yield (2/16/10) |
.26 |
1.53 |
2.17 |
| Current as % of Mean |
11 |
57 |
99 |
| Current as % of Historical Real Return on Nominal Bond |
12 |
67 |
92 |
Five- and 10-year TIPS yields remain below their historical means, and the 20-year TIPS still appears more favorable in its relationship to historical yields.
As the TIPS curve is positively sloped, you're still able to pick up additional yield for increasing maturity without taking inflation risk. The TIPS of 2025 may still be considered a "sweet spot" for buying TIPS. As of Monday, the current yield on the TIPS of 2020 was about 1.53 percent, and the current yield on the TIPS of 2025 was about 1.98 percent. Thus, there's about an extra nine basis points a year currently available by extending the maturity from 10 to 15 years.
However, it may not be worth it to go beyond 2025. You'll only pick up a few basis points for each additional year, which may not be enough compensation for the extension risk, given that yields are still below historical averages.