Treasury Inflation-Protected Securities (TIPS) what they are an how to trade them. Treasury Inflation-Protected Securities (TIPS) what they are an how to trade them. Treasury Inflation-Protected Securities (TIPS) what they are an how to trade them.

Treasury Inflation-Protected Securities (TIPS) what they are an how to trade them.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  As inflation expectations continue to rise, it is crucial to understand how to hedge against it. In this page, we look at Treasury Inflation-Protected Securities (TIPS) and explain what they are and what are the risks involved in trading with them.


Given the extraordinary times we are living in, Saxo Bank has decided to make Treasury Inflation-Protected Securities (TIPS) available for trading in the Saxo platform. We believe that inflation is the greatest threat to one's saving and investments. Thus it is crucial to understand how to hedge from inflation risk as underlying inflation expectation continue to rise.

What are Treasury inflation-protected securities (TIPS)?

TIPS are Treasury bonds created to protect investors against inflation risk. They pay a fixed coupon; however, the dollar amount of the interest payment goes up and down according to changes in inflation (CPI Index) as the principal it is adjusted accordingly.

Suppose you own $1,000 in TIPS paying a coupon rate of 1%, at the end of the year you will receive:

  1. If inflation doesn't rise: $10 coupon.
  2. If inflation rises by 2%: $10.2 coupon. The principal will rise by 2%; hence the coupon will need to be calculated on a principal of $1,020.
  3. If inflation falls by 2%: $9.8 coupon. The principal will fall by 2%; hence the coupon will need to be calculated on a principal of $980.

Risks and benefits of holding TIPS

Close to zero market risk

Because the US government issues TIPS, their market risk is close to zero, precisely as Treasury bonds.

Low Inflation and deflation risk

TIPS are indexed for inflation, thus offer low inflation risk. Deflation may cause the price of these securities to fall. However, if held until maturity, TIPS will always return either the inflation-adjusted principal or the par value at maturity of the bond, whatever it is higher. Therefore, there is a natural deflation protection embedded in the structure of the bond.

Liquidity and price fluctuation risk

Other risks of TIPS are price fluctuation and liquidity risk. As a matter of facts, inflation linkers are not as liquid as traditional Treasuries, hence during periods of volatility price may vary significantly. Additionally, the value of TIPS is affected more by expectations in inflation changes rather than the actual movement of inflation.

Market drivers of TIPS prices

The volatility caused by the Covid-19 pandemic this year creates a perfect opportunity to understand what are the main drivers underpinning TIPS' prices.

Inflation expectations

In March, TIPS yields shot higher as inflation expectations in the short-term fell. This was mainly due to a drop in energy prices and the expectation that social distancing measures would also drive consumer prices lower.

Lower inflation expectations also provoked an inversion of the TIPS yield curve in March (in yellow). However, as the economy reopens and activities resume, we see the US TIPS yield curve normalizing (in green).

Source: Bloomberg.

Looking ahead, inflation expectations are rising, underpinning more upside for TIPS. In particular, expected inflation in the next three years ahead rose faster than the expected inflation for the next 5 to 10 years.

US Federal Reserve bond-buying programme pushes TIPS prices higher

As of March, the prices of TIPS have risen considerably pushing their average yield to the lowest point since Bloomberg Barclays index started to track it in 1997. TIPS’ negative yields may discourage investors; however, the reason why TIPS have rallied significantly is because of the Federal Reserve bond-buying program. As per Bloomberg data, since March, the FED has doubled its holding of TIPS.

At the same time, TIPS issuance has slowed down since 2013 until today, stabilizing the share of TIPS over Treasuries (excluding T-bills and floating-rate notes) in the market since the beginning of 2018. Therefore, with the FED increasing the holding of these instruments if inflation expectation unexpectedly rises, there might not be enough offer to satisfy TIPS demand while investors change Treasuries for inflation linkers.

Why buying TIPS gives better protection against inflation compared to gold?

Compared to TIPS, gold is not an isolated inflation play. Gold is sensitive to risk appetite, to the value of the USD, and it is also used as a geopolitical instrument. Gold doesn't pay dividends, but it might give comfort to investors that are afraid about a possible default of the issuer.

TIPS, on the other hand, are a good diversification instrument because they do not correlate with fixed income or equity products. Additionally, the price inflation protection built-in pays a steady cashflow.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992