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TIPS Reaches an All-Time Record Low of -1.67%. What Are the Implications?

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The 5-year note is the most overvalued in history.

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On November 26, 2008 the Five-Year TIPS reached its post 2002 high (data on the Fed website starts January 1, 2003) of 4.24%. Note the Fed announced QE1 the previous day. The 5-year note was yielding 2.01%. Since then, the 5-year TIPS has dropped by 139% and the 5-year yield has dropped by 64%.

So over the long run, that was a good time to buy both TIPS and the 5-year note.

On September 14, 2012, buyers of the 5-year TIPS were locking in a -1.67% real return. The modern day rendition of the old Henry Youngman joke for this is "Take my purchasing power. Please."

Is the 5-year TIPS a worse investment than the 5-year nominal note? Well that depends on whether or not inflation will be above or below 2.39% annualized over the next five years.



Since January 2003, TIPS five year implied inflation predictions have ranged from -2.24% to 2.94%. The average anticipated inflation was 1.95%. The actual five-year annualized inflation ranged from 1.89% to 3.67%. The average actual inflation was 2.50%. The forecast error ranged from -2.12% (underestimated inflation) to 0.82% (overestimated). The average forecast error was -0.2%. The reason why that number is a not the exact match between the anticipated and actual averages (1.95%-2.55% = -0.55%) is because there is an extra 60 months of data for the predicted inflation rate. In any event, if TIPS are systematically undervalued by a little bit, it suggests that they are typically a better bet than normal Treasuries (unless one has a strong opinion of less than anticipated inflation).
No positions in stocks mentioned.
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