From the Economist….
As a result of this security, TIPS have traditionally offered a pretty low yield. But recently that yield has been rising; the 20-year issue was this week offering 3%. As a contrast, the index-linked gilt (a similar security issued by the British government) with a 2035 maturity was offering a yield of just 1.5%. Three percent is better than the yield on offer from most money-market funds, and it will rise with inflation.
And then latter on in the same article…
Nevertheless, lower inflation seems fully reflected in prices, to say the least. One measure of value is the break-even inflation rate, which is the rate of annual price rises above which the investor makes more from TIPS than from conventional Treasury bonds. Mark Capleton, a strategist at Royal Bank of Scotland, says the break-even inflation rate is zero over the next five years and just 1% over the next ten. It would be a remarkable period of history for such a low rate to be achieved. Indeed, the temptation for governments round the world in the face of the credit crisis will be to inflate the problem away.
Just to make it perfectly clear, the only way you would make more money buying a conventional Treasury bond over TIPS (which is the same as a treasury bond except it is indexed for inflation) is if inflation stays below zero over the next 5 years and below 1% over the next 10. If inflation stays at 0% or above for the next 5 years or above 1% for the next 10, you will make more money buying TIPS. With those kinds of odds, why in the world would you ever buy a conventional Treasury bond.
To me, this is proof that the treasury market has gone insane. I can imagine that inflation rates might reach reach zero for one year. But 5 years? I think you will see solders on the streets handing out free dollar bills before you see that happen. I don’t have much confidence in the powers that be, but I have confidence that the can create inflation if they really set their mind to it.
