Why the TIPS Rally Might Not Be Real

When the specter of inflation looms, Treasury inflation protected securities ^[1] (TIPS) become more attractive investments for those who are looking to hedge their positions. However, inflation ^[2] is nowhere in sight in our current economy, and most economists expect it to remain that way for the foreseeable future. That's why the sudden influx of money into TIPS that ended in April is probably not an indicator that real inflation is on the horizon. The rally into these instruments is more likely the result of other economic factors that have asserted themselves than any real fear of inflation. Some financial experts believe that the recent glut of money into these securities is little more than an illusion.

The Real Cause

The actual reason that over $2 billion moved into TIPS in a six-week period ending in April is more likely because these securities simply became under priced as a result of fears about deflation ^[3]. The Consumer Price Index ^[4] has only gained a measly percent over the past 12 months. The National Association of Business Economists estimates that it will only rise by 1% in 2016. And the 10-year Treasury ^[5] note is still yielding less than 2%, which also indicates that inflation is not a concern. (For more, see: Introductio n to Treasury Inflation-Protected Securities ^[6].)

This pressure pushed TIP prices down to a level where they offered no premium over Treasury securities and then buyers moved in to restore the balance between supply and demand. The current yield on TIPS implies an inflation rate of just above 1.5% for the next 10 years, which is very low. But this is still above the 1.21% rate that TIPS had back in February when deflationary fears took hold. That was the lowest level that TIPS have been at since March of 2009.

However, mutual funds that invest in TIPS have also seen a surge in prices this year. The average TIPS fund has gained more than 3% this year, beating out both high-yield ^[7] and intermediate-term government bond funds. The Barclay's TIP Index has risen by almost 5% this year as well. Here are some other factors that could continue to drive up the price of TIPS in the market: (For more, see: Why Some Investors Are Tilting Toward TIPS ^[8].)

Higher energy prices – The price of oil is rebounding in the markets, and high energy prices usually mean higher prices for TIPS.
Rising shelter and healthcare prices – Some investors believe that inflation is on the horizon because the cost of shelter and healthcare are going up. Inflation for both sectors has increased by almost 4% in the past year.
Changing Federal Reserve ^[9] policy – The bond markets were nervous that the Fed might start raising interest rates too aggressively. But their recent decisions have allowed for inflation to creep in if it wants to.
Low yields – Although the current yield for tips is a paltry 0.2%, better rates are not to be found elsewhere, and investors who are looking to get into TIPS while they are cheap still have time to do so.

The Bottom Line

Although the stage has been ultimately set for TIPS to move upward in price at some point, there is little indication that this will happen any time soon. There is greater fear of deflation than inflation at this point, despite the Fed leaving the door open for the latter. There are several factors that can affect the price of TIPS, and some analysts feel that they still have some upside. But the influx of money into these instruments earlier this year should not be viewed as a precursor to inflation now. For more information about TIPS and how they can benefit you, consult your financial advisor ^[10]. (For more, see: Top 5 TIPS ETFs ^[11].)