Treasury Inflation-Protected Securities (TIPS) will continue to outperform nominal Treasuries, besides providing a valuable hedge against inflation

Bonds
Althea Spinozzi

Fixed Income Strategist, Saxo Bank Group

Summary:  Treasury Inflation-Protected Securities (TIPS) have outperformed Treasuries this year. Because they offer higher duration than their nominal counterparts they gain the most out of low and stable interest rates. Hence, regardless of inflation, they will most likely continue to shine in 2021 as the Federal Reserve will have no alternative other than keeping interest rates low for longer if the consumer price index fails to rise. In case of soaring inflation, TIPS offer a valuable build-in hedge that nominal Treasuries don't have besides of not offering any buffer against it.


We are about to close an exceptional year where the unthinkable became real, and bears were proven wrong once again in a period of abnormally high volatility.

Treasuries rose to the stars as investors were seeking safe havens and the Federal Reserve expanded monetary policies in an effort to sustain an inevitable economic decline amid the harsh lockdowns imposed by the Covid-19 pandemic. Blinded by the vital role of central banks in the economy and a rising stock market, investors decided to sit on large amounts of Treasuries. They speculate that interest rates will remain low for longer; however, they are failing to see that the real winners this year will be inflation-linked securities (TIPS).

According to the Bloomberg Barclays indexes, since the beginning of the year, TIPS have provided a substantial return of 9.3%. In comparison, Treasuries have only provided around 8%. The reason why inflation-linked securities outshine Treasuries stems from their structure, which enables them to perform even as the consumer price index is lagging.

TIPS have higher duration compared to their nominal counterparts providing a bigger upside when interest rates are stable or falling. Besides, as the Federal Reserve said that it would not cut interest rates below zero, Treasuries have a "floor" of 0%. In contrast, TIPS do not have limits concerning how much they can fall into negative territory, and now they offer approximately -1% in yield for a 10-year maturity.

Another factor that supports TIPS prices is the limited supply of these securities. Even though the Treasury has announced that TIPS issuance is poised to increase next year, they will continue to represent the smallest share of Treasuries outstanding.

TIPS will outperform nominal Treasuries in 2021 regardless of inflation

It is critical to understand that next year TIPS' performance does not depend merely on inflation.

In the past few weeks, the market has been focusing over the Federal Reserve course of action and the likelihood that it will need to expand its bond-buying program to buy longer-dated maturities in an effort to keep interest rates low for longer. If that were the case, TIPS prices would continue to be supported even if inflation will not rise.

This brings us back to the reflation theme, which has characterized the market since the US presidential election, provoking a steepening of the yield curve. Whenever we talk about the steepening of the yield curve, we have to put things into perspective. The yield curve can steepen because the front part of the yield curve falls faster than long-term yields (bull steepening). Otherwise, it can steepen because long-dated yields rise faster than near term yields (bear steepening).  Since the end of 2018 until recently, we have witnessed a bull steepener, but the Covid-19 pandemic changed this pattern, and the yield curve is now steepening because interest rates are soaring. The rise in the consumer price index has contributed to interest rates' acceleration, but as of August, it started to stabilize. Suppose yields continue to soar, but the CPI index lags. In that case, the Fed will not have other choices than keeping interest rates low for longer until inflation ticks up again.

Hence, in case of reflation, TIPS will provide a hedge, but in case inflation doesn’t rise we will most likely see the Fed keeping interest rates around current levels.

In this context, TIPS offer a win-win solution.

The biggest threat to TIPS performance at this point is rising interest rates without inflation catching up. If that were the case, the price of inflation-linked securities would fall, and the inflation hedge will not be activated, providing any extra cashflow. This scenario is not feasible as the Fed will not put at risk years of expansionary monetary policy. Not even deflation is a credible threat at this point of time as the macroeconomic backdrop points towards inflation.

The biggest market's problem right now is that it is underestimating inflation. Investors are sitting on securities providing a fixed coupon, which can sensibly reprice if there is an upside surprise in inflation. Within this context, nominal Treasuries are the worst investment one can hold on to as they do not provide any buffer for the real risks ahead of us.

How to gain exposure to Treasury Inflation-Protected Securities (TIPS)

You can trade select and trade various TIPS out of the Saxo platform. You can also select one of the ETFs available in the platform such as the below:

Saxo Ticker

Description

Currency

ISIN Code

XG7G:xswx

Xtrackers II Global Inflation-Linked Bond ETF

CHF

LU0641007421

DBXH:xetr

Xtrackers II Global Inflation-Linked Bond ETF

EUR

LU0290357929

XGIN:xmil

Xtrackers II Global Inflation-Linked Bond ETF

EUR

LU0290357929

XGIU:xetr

Xtrackers II Global Inflation-Linked Bond ETF

EUR

LU0908508814

GILE:xlon

iShares Global Inflation Linked Govt Bd UCITS ETF

EUR

IE00BD8PH174

BINFU:xmil

Amundi Index Breakeven Inflation USD 10Y

EUR

LU2037750168

IS3V:xetr

iShares Global Inflation Linked Govt Bond UCITS ET

EUR

IE00BKPT2S34

XGII:xmil

Xtrackers II Global Inflation-Linked Bond UCITS ET

EUR

LU0962078753

GIST:xmil

Lyxor Core Global Inflation-Linked 1- 10Y Bond(DR)

EUR

LU1910939849

ITPS:xmil

iShares Dollars TIPS ETF

EUR

IE00B1FZSC47

TPSA:xams

iShares USD TIPS UCITS ETF

EUR

IE00B1FZSC47

IBC5:xetr

iShares USD TIPS UCITS ETF EUR Hedged

EUR

IE00BDZVH966

TIP10D:xmil

UBS Bloom Barc Tips 10+ Ucits ETF

EUR

LU1459802754

SYBY:xetr

SPDR Bloomberg Barclays U.S. TIPS UCITS ETF

EUR

IE00BZ0G8977

TIPU:xmil

Lyxor Core US TIPS (DR) UCITS ETF

EUR

LU1452600270

TIP1D:xmil

Bloomberg Barclays TIPS 1-10 UCITS ETF

EUR

LU1459801434

TIPE:xmil

Lyxor Core US TIPS (DR) UCITS ETF

EUR

LU1452600437

GILI:xlon

Lyxor ETF iBoxx UK Gilt Inflation Linked

GBP

LU1407893301

SGIL:xlon

Global Inflation Linked Government Bond UCITS ETF

GBP

IE00B3B8PX14

XGIG:xlon

Xtrackers II Global Inflation-Linked Bond ETF

GBP

LU0641007264

ITPS:xlon

iShares USD TIPS UCITS ETF

GBP

IE00B1FZSC47

ITPG:xlon

iShares USD TIPS UCIT- ETF

GBP

IE00BDZVH859

WIP:arcx

SPDR FTSE Int Gov Inflation-Protected Bond ETF

USD

US78464A4904

IGIL:xswx

iShares Global Inflation Linked Gov Bond UCITS ETF

USD

IE00B3B8PX14

VTIP:xnas

Vanguard Short-Term Inflation-Protected Securities

USD

US9220208055

ITPS:xswx

iShares USD TIPS

USD

IE00B1FZSC47

TIP:arcx

iShares Barclays TIPS Bond Fund

USD

US4642871762

STPZ:arcx

PIMCO 1-5 Year US TIPS Index

USD

US72201R2058

LTPZ:arcx

PIMCO 15+ Year US TIPS Index

USD

US72201R3049

SCHP:arcx

Schwab US TIPS ETF

USD

US8085248701

TIPZ:arcx

PIMCO Broad U.S. TIPS Index Fund

USD

US72201R4039

IDTP:xlon

iShares $ TIPS UCITS ETF

USD

IE00B1FZSC47

STIP:arcx

iShares 0-5 Year TIPS Bond ETF

USD

US46429B7477

TIPS:xlon

SPDR Bloomberg Barclays U.S. TIPS UCITS ETF

USD

IE00BZ0G8977

TIP5:xlon

iShares USD TIPS 0-5 UCITS ETF

USD

IE00BDQYWQ65

SPIP:arcx

SPDR Series Trust Portfolio TIPS ETF

USD

US78464A6560

TIPU:xlon

Multi Units Luxembourg Lyxor Core US TIPS ETF

USD

LU1452600270


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