TIPS Spread
Categories: Bonds
A “TIPS spread” is used to predict investors’ expectations about changes to the inflation rate. If the spread is narrow, investors expect the inflation rate to stay where it is. If it’s wide, they expect the inflation rate to go up.
So where does this spread come from? Well, we take a look at the yield of a U.S. Treasury security with a certain maturity date. Then we look at the yield of the TIPS—that’s Treasury inflation protection securities—with the same maturity date, and we compare the two. The bigger the difference—in other words, the wider the spread between the two yields—the higher inflation is expected to jump.
Is the TIPS spread a 100% reliable indicator of inflation rate changes? Eh, not always. It’s a good indicator of whether or not there’s going to be an inflation rate change, but it tends to underestimate what that change will be more often than not. The Fed tries to keep inflation somewhere in the neighborhood of 2%, but it can’t always account for or predict everything that’s going to happen in the markets. And so, just as with every other indicator out there in the world, the TIPS spread is a tool that should be used in conjunction with other financial indicators and analyses if we’re going to use it to guide our investment decisions.
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Finance: What are T-Notes, T-Bonds and T...18 Views
Finance allah shmoop what are t notes t bills and
tips All right we'll see that tea in there Well
it stands for treasury and all of these air one
flavor or another of government debt that is the u
s government raises cash for itself teo fix roads build
bridges and erect statues of lebron james dunking on the
statue of liberty or you know whatever else he thinks
the public wants or needs it does that by auctioning
off these debt securities with the promise of its full
faith and credit to pay back the money is the
paper specifies well t notes are quote mid range unquote
paper in that they generally have maturity ease of two
three five seven and ten years that's a teen note
t notes carry a stated interest rate and look a
lot like a normal corporate bond paying interest twice a
year T bills on the other hand are generally very
short term paper usually coming due within a few days
all the way up to a year they're sold or
auctioned at a discount meaning that the t bill might
promise to pay a thousand bucks if it comes due
In six weeks you might pay nine hundred ninety six
dollars for it and you get a whopping fee Four
bucks an interest for your six weeks hard work of
owning that t bill and just you know sitting there
kind of looks like a zero coupon bond Okay so
now we have tips that's tips treasury inflation protected securities
tips as in show us your tips getting Why do
we have such a thing Well the problem with super
duper safe bonds like those of the u s government
is that investors holding them a long time often do
worse after taxes than inflation meaning that if inflation is
growing at three percent a year in their bonds are
only returning one percent a year after tax while then
the investors actually losing two percent a year in buying
power and that's a problem in nineteen nineties when investors
started to realize this issue well they began Tio you
know stop buying u s government bonds and that's a
huge problem for a country that desperately needs to borrow
cash all the time So rather than risk a liquid
marketplace where there's just no buyers buying government paper uncle
Sam created tips which basically adjust the end value of
the principle that investors get based on the c p
i or consumer price index which is a measure of
the average selling prices of a carton of milk a
gallon of fuel a dozen eggs and a grand slam
breakfast at denny's Basically what happens is that the price
of the principal the investor gets back goes up with
inflation over time So they're not losing buying power and
that's a big deal That's it go Enjoy your grand 00:02:33.995 --> [endTime] slam It'll be fourteen thousand dollars in fifty years