ETFs following Treasury Inflation Protected Securities have hit a rough patch lately. Blame subdued inflation expectations and rising real yields.
For example, the Consumer Price Index fell 0.4% in April after slipping 0.2% in March. The so-called core CPI, which excludes food and energy, held steady with a slight 0.1% increase in April.
On Wednesday, investors will get inflation data for May, and the consensus core CPI forecast is a small 0.1% rise. [Plunging TIPS ETF]
The iShares TIPS Bond ETF (NYSEArca: TIP) is off more than 4% the past three months, while iShares 7-10 Year Treasury (NYSEArca: IEF) is unchanged. The TIPS fund is falling harder than the Treasury ETF of similar duration as investors scale back their inflation outlook. Speculation the Federal Reserve may taper its bond purchases is also having an impact. [TIPS ETF Down More Than Treasuries]
In fact, the yield on 10-year TIPS has flipped positive for the first time in over a year. Investors pulled more than $400 million from TIP last week.
“It’s a strange concept. People were writing a check to the U.S. Treasury for the privilege to own TIPS,” said Richard Gilhooly, an analyst with TD Securities, in a recent WSJ report. “Now, they are finally demanding some compensation.”
Next page: Breakeven rate
Bond investors keep a close eye on the “breakeven rate” between TIPS and Treasuries. This is determined by comparing the yields of regulator government bonds against inflation-protected securities of the same durations. If inflation averages more than the breakeven rate over a given time period, then investors would be better off owning TIPS than normal Treasury bonds.
The breakeven rate has been falling recently.
“TIPS investors have been hit by a double-whammy of headwinds in recent weeks: tame inflation in the U.S. and comments from Federal Reserve officials indicating they are making plans to cut back purchases of Treasuries and mortgage bonds,” WSJ reports.
“For TIPS to do well, you need either inflation or the Fed,” said Chris McReynolds, head of U.S. Treasury Trading at Barclays, in the article. “Right now, you have neither.”
Markets are focused on the Fed decision Wednesday followed by a press conference with Ben Bernanke.
It’s important to remember that TIPS are sensitive to interest rates so related ETFs can lose value when Treasury yields rise. Bond prices and yields move in opposite directions.
Jeffrey DeMaso, director of research at Adviser Investments, in a recent note pointed out that investors binged on TIPS because they thought the Fed stimulus would spark inflation. But that hasn’t happened.
“Paradoxically, as the U.S. recovery looks on track, investors are suddenly less concerned about inflation, and are selling TIPS,” he wrote.
“But TIPS are more attractive today than they were several months ago—inflation looks to be a greater risk today, the hurdles for inflation protection are lower, hence that protection is cheaper,” DeMaso added.
iShares TIPS Bond ETF
Full disclosure: Tom Lydon’s clients own TIP.