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TIPS yields
Old 12-01-2008, 09:07 AM   #1
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TIPS yields

I was just looking through some bond listings on E*Trade (after reading Hussman's weekly commentary) - and there are quite a few individual TIPS issues out there with maturities 6 or 7 years out yielding 4%+ real...

If thats the best we can realistically hope to withdraw anyway, isn't now a great time to load up on TIPS and just hold until redemption?

Is there any downside, short of a US bankruptcy?
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Old 12-01-2008, 09:25 AM   #2
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Quote:
Originally Posted by cyclone6 View Post
I was just looking through some bond listings on E*Trade (after reading Hussman's weekly commentary) - and there are quite a few individual TIPS issues out there with maturities 6 or 7 years out yielding 4%+ real...

If thats the best we can realistically hope to withdraw anyway, isn't now a great time to load up on TIPS and just hold until redemption?

Is there any downside, short of a US bankruptcy?
No downside that I can see, other than giving up the hope of speculative gain either in stocks or in straight treasuries. Some pundits are claiming that 10 year rates will go to 1%. While they may, IMO the potential downside with this is huge.
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Old 12-01-2008, 09:28 AM   #3
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Originally Posted by cyclone6 View Post
I was just looking through some bond listings on E*Trade (after reading Hussman's weekly commentary) - and there are quite a few individual TIPS issues out there with maturities 6 or 7 years out yielding 4%+ real...

If thats the best we can realistically hope to withdraw anyway, isn't now a great time to load up on TIPS and just hold until redemption?

Is there any downside, short of a US bankruptcy?
I don't know about a downside, just a possibility that other choices (i.e. regular Treasuries, federally insured CDs, et cetera) would look better in retrospect.

At these real yields, though, it makes it a lot easier to lock these in now and reduce my equity allocation moving forward. With my fixed income guaranteed to yield a real 3.5% or more, I don't need as much real return (or risk) from equities. That to me is one of the main benefits. I'm relatively comfortable with a conservative 50/50 AA (once stocks are no longer in the toilet) with that kind of guaranteed real return on bonds...
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Old 12-01-2008, 09:29 AM   #4
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I believe the high yield has built into it the risk that we will have some deflation or very low inflation. If we do have deflation, the actual yield will be lower that the real rate. In which case you would have been ahead with plain old FDIC insured CDs. I've actually been looking at TIPS myself, more in the form of a fund. I'd be interested in opinions of some of the experts here, as well.
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Old 12-01-2008, 09:33 AM   #5
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Be careful doing your analysis. TIPS inflation adjustments are based upon a 2-month lag, so the December adjustment is based upon October's change in CPI-U, which was negative 1%. This means any existing TIPS you buy today will lose 1% of it's inflation-adjusted principal this month, and this is known today. So those yields are likely to be overstating the real YTM.

If you wait until January's auctions of the 10-year and 20-year TIPS, you can buy them without any inflation-adjustment already built in, so you will not be exposed to this effect if you hold them until maturity.

BTW, Bloomberg is showing the real YTM's on the 5 and 10 year TIPS to be about 2.1% and 2.4%, respectively.
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Old 12-01-2008, 09:38 AM   #6
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If you wait until January's auctions of the 10-year and 20-year TIPS, you can buy them without any inflation-adjustment already built in, so you will not be exposed to this effect if you hold them until maturity.
And, of course, the YTM on the newly-issued bonds will be considerably lower to account for the reduced risk factor.

TIPS with more of an inflation adjustment are yielding closer to 3.5% and higher while TIPS issued in 2008 with a very small inflation factor built in are priced to yield closer to 3%.
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Old 12-01-2008, 09:41 AM   #7
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TIPS with more of an inflation adjustment are yielding closer to 3.5% and higher while TIPS issued in 2008 with a very small inflation factor built in are priced to yield closer to 3%.
Not according to Bloomberg, and Bloomberg prices the "on-the-run" TIPS.
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Old 12-01-2008, 09:42 AM   #8
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I guess its time for a little research. I'm not sure how TIPS work in a deflationary cycle. If you buy a TIPS at auction - and you lock in a 3.5% rate - you are guaranteed that, correct? Even with deflation?

Or do they add a hypothetical -1% inflation rate to pay out only 2.5%?

Even the Vanguard Inflation Protected Bond fund has a current real rate of 3.62%...
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Old 12-01-2008, 09:57 AM   #9
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I'm liking my I-bonds these days paying nearly 9%
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Old 12-01-2008, 10:00 AM   #10
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I guess its time for a little research. I'm not sure how TIPS work in a deflationary cycle. If you buy a TIPS at auction - and you lock in a 3.5% rate - you are guaranteed that, correct? Even with deflation?

Or do they add a hypothetical -1% inflation rate to pay out only 2.5%?
If you buy TIPS at auction, you get 100 back at maturity, even if there is deflation, so you will realize at least the stated real YTM, if you hold until maturity.

However, as I understand it, the index ratio can go below 1.0000 in the interim period, so deflation can theoretically cause loss of nominal principal, if you sell the TIPS before maturity.
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Old 12-01-2008, 10:22 AM   #11
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Institutional - TIPS/CPI Data

This link will take you to a list of all the TIPS issues that have been made. The highest coupon was 4.25% and only one was this high. Most are lower, much lower.

When you buy a TiP from another investor, via a broker, you pay the market price for that bond, usually stated as a number like 95 or 102 etc. that represents that percentage of the face of the bond. In addition you must pay the amount of accumulated inflation represented by the Treasury Index associated with that bond.

Normally, the yield to maturity quoted by the broker does not include future inflation.

Like all bonds, there may be marketability issues in the future, so you should plan to hold them to maturity.
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Old 12-01-2008, 10:24 AM   #12
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Originally Posted by FIRE'd@51 View Post
If you buy TIPS at auction, you get 100 back at maturity, even if there is deflation, so you will realize at least the stated real YTM, if you hold until maturity.

However, as I understand it, the index ratio can go below 1.0000 in the interim period, so deflation can theoretically cause loss of nominal principal, if you sell the TIPS before maturity.
Right -- which is a reminder that when we say TIPS are pretty much a "sure thing" in terms of guaranteeing a certain real return, that assumed buying individual securities and holding to maturity. Selling before maturity (or buying TIPS funds) could yield less overall, or even lose money.
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Old 12-01-2008, 12:28 PM   #13
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Be careful doing your analysis. TIPS inflation adjustments are based upon a 2-month lag, so the December adjustment is based upon October's change in CPI-U, which was negative 1%. This means any existing TIPS you buy today will lose 1% of it's inflation-adjusted principal this month, and this is known today. So those yields are likely to be overstating the real YTM.

If you wait until January's auctions of the 10-year and 20-year TIPS, you can buy them without any inflation-adjustment already built in, so you will not be exposed to this effect if you hold them until maturity.

BTW, Bloomberg is showing the real YTM's on the 5 and 10 year TIPS to be about 2.1% and 2.4%, respectively.
I find this somewhat confusing. This table from the WSJ Treasury Inflation-Protected Securities (TIPS) - Markets Data Center - WSJ.com

purports to have yields for all outstanding TIPS. The two bonds that Bloomberg uses are distinctly below their neighbors. The "5 year" is due 4/15/2013 with a coupon of 5/8 %, and the WSJ has a yield of 2.267% vs. yields over 4% for bonds maturing 6 months earlier or later. I understand the deflation risk with existing bonds, but the numbers look surprisingly large.

Similarly, the "10 year" is due 7/15/2018 and the WSJ has a yield of 2.563%, while the bonds due 6 and 12 months earlier have yields over 3%.
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Old 12-01-2008, 01:21 PM   #14
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I find this somewhat confusing. This table from the WSJ Treasury Inflation-Protected Securities (TIPS) - Markets Data Center - WSJ.com

purports to have yields for all outstanding TIPS. The two bonds that Bloomberg uses are distinctly below their neighbors. The "5 year" is due 4/15/2013 with a coupon of 5/8 %, and the WSJ has a yield of 2.267% vs. yields over 4% for bonds maturing 6 months earlier or later. I understand the deflation risk with existing bonds, but the numbers look surprisingly large.

Similarly, the "10 year" is due 7/15/2018 and the WSJ has a yield of 2.563%, while the bonds due 6 and 12 months earlier have yields over 3%.
If you look at the "accrued principal" column in the WSJ table, you will see that the TIPS with yields over 3% have significantly higher accrued principals. The accrued principal divided by 1000 is the index ratio. The most recently issued TIPS, which are the ones quoted on Bloomberg, have significantly lower inflation-adjusted principals (since they have been around for a shorter time). For example, the 1.375% of 7/15/2018 has an accrued principal of 1014 (index ratio = 1.014). This means it has only 1.4% inflation-adjustment built into the maturity value (and it is guaranteed to lose 1% of that this month because of the October decline in CPI-U), so that, after this month, it can only lose 0.4% to deflation if it is held until maturity. If you compare that to the one above it in the table, the 1.625% of 1/15/2018, you can see that it has 4.4% of inflation-adjustment built in, so it has more deflation risk. Presumably, this is why the latter has a higher yield.
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Old 12-01-2008, 02:20 PM   #15
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Let me try to quantify my above post a bit, with a "back of the envelope" calculation.

From the WSJ table the price of the 1.625% of 1/15/2018 is 89. Relative to the 1.375% of 7/15/2018, it can lose 3% more to deflation. Since there are 19 interest payments of 0.8125% left, the YTM at a PV of 89 and FV of 100 (according to my HP12C) equals 2.96%. If I raise the PV to 92, I get 2.58%, so there is a potential loss of 38 basis points of one TIPS relative to the other, if both are held until maturity, so the yield difference in the table doesn't look unreasonable to me.
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Old 12-01-2008, 07:53 PM   #16
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I'm liking my I-bonds these days paying nearly 9%
You dog you, when did you buy? Late 90s?


Mine are paying ~6 and I'm pretty happy about it.
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Old 12-01-2008, 11:07 PM   #17
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In January of this year TIPS went to incredibly low yields. At that time the market was clearly wrong. There were investors then looking in the rear view mirror and buying because the last 12 months had been really good.

Now we have somewhat the opposite situation. It is very unlikely that we will have deflation for an extended period of time. That is why I've bought up to my limit in TIPS.

For those of you who are still confused, I'd take a look at the many posts on the Bogleheads site on TIPS. In particular, see Larry Swedroe's posts.
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TIPs vs Other Bond Funds?
Old 12-02-2008, 06:08 AM   #18
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TIPs vs Other Bond Funds?

Well when I use Lippers Chart on A Per $10k Invested and comparing VIPSX to VFITX, VFIIX? and then for past 10,5,3 yrs?

Very Little reason for me to Own Tips..
And the YTD Rtns on VFITX is Unreal.. + 9% now
While the Tips are Dwn in the Negative column
And seeing as Inflation is not an issue now or in the near future and Deflation is?

They got off to a great start in the last Bear Yrs, but slacked off in 05' & 06', then spiked in 07' and now? In the dumpster.., thus has been pretty volatile for my taste..

I Mybe wrong, but I still can't see much reason to own tips at this time

and For my Short Term $ ( 3 yrs COH for bills ) ? Fido's New Bond Fund> FIBIX..+11% YTD as of 12/1/08' has been my best Bond Fund this yr, so far..

Some have been saying Maybe time to Go back into HYld Corp. ? But not so sure..

BTHOM!
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Old 12-02-2008, 10:45 AM   #19
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Me thinks the "volitility" of TIPS exists only of you sell them before maturity, or hold a TIPS fund. If you plan to do either of those things, there are probably better choices.
But if you buy actual TIPS and hold them to maturity, you WILL get the interest along the way, and they WILL be worth AT LEAST face value when they mature; probably more because of inflation.
Stocks and bond funds may or may not perform better over the specific time period, but you can't know what they will be worth on a given date because they have no maturity date.
At least that's the way I understand it, waiting for corrections...
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Old 12-02-2008, 10:52 AM   #20
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If you look at the "accrued principal" column in the WSJ table, you will see that the TIPS with yields over 3% have significantly higher accrued principals. The accrued principal divided by 1000 is the index ratio. The most recently issued TIPS, which are the ones quoted on Bloomberg, have significantly lower inflation-adjusted principals (since they have been around for a shorter time). For example, the 1.375% of 7/15/2018 has an accrued principal of 1014 (index ratio = 1.014). This means it has only 1.4% inflation-adjustment built into the maturity value (and it is guaranteed to lose 1% of that this month because of the October decline in CPI-U), so that, after this month, it can only lose 0.4% to deflation if it is held until maturity. If you compare that to the one above it in the table, the 1.625% of 1/15/2018, you can see that it has 4.4% of inflation-adjustment built in, so it has more deflation risk. Presumably, this is why the latter has a higher yield.
Thanks for the reply. I'm slow replying because I've been trying to do some calculations. I think you are correct in saying that I've under-estimated the importance of the floor. Not having an HP, I set up the cash flows of the bonds on a spreadsheet and calculated IRRs.

If I'm reading everything correctly, the coupons on the two bonds are impacted identically by deflation. If the CPI had an immediate decrease of 3% and stayed there, both bonds would have 3% decreases in coupons from today's levels. The difference is the maturity value, where one bond can drop 1.4% from the Dec 1 value, and the other can drop 4.2%.

I was surprised by how much weight the maturity value gets in the IRR calculation. I'm not accustomed to looking at 9 year bonds with coupons around 1.5%. In these cases the maturity value is a much bigger deal than the coupon. When I calculated IRRs assuming significant deflation, the bond with the 1043 adjusted principal really did lose more value than the bond with the 1014. By my calculation, 5% deflation could cost the 1043 bond 47bp of yield, while the 1014 only loses 20bp.

But, that calculation assumes a 100% probability that we'll have 5% deflation. I'd think that the "most likely" case is still that the CPI in 2018 will be higher than it is in 2008. Today's prices should reflect some weighted average of inflation and deflation scenarios, and the market seems to be weighting the deflation possibility pretty heavily. If I were buying a single bond, I think I'd go against the market and buy the one with the bigger deflation risk. It seems to be paying pretty well for the magnitude of the risk.
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