For another purpose, I had reason to look up TIPS yields.
The current Treasury Inflation-Protected Security (TIPS) yields are -1.27% (5 years) -0.98% (10 years) and, amazingly, -0.35% (30 years). You pay them 0.35% per year for a stable real value. I did not realize it was this low.
The context. I serve on the advisory board of a small nonprofit that has an endowment. The endowment is intended to be perpetual. We're discussing the equity vs. fixed income allocation. I wanted to lay out the options. If they want absolute safety of principal and payout, under a perpetual constraint, they can pay out... -0.35% of the principal every year! I advised they accept some risk in the payout stream.
It is not common for foundations to link the payout rate to the portfolio beta or composition. On economic grounds it should be. If you want a perpetual investment, the payout rate has to relate to the average portfolio return. Fixed income should have a lower payout rate than equity.
Of course, some payouts are set by IRS rules or by a conflict between managers and donors, and there apparent illogic can serve other purposes.
But the market does still expect 1-2% inflation. Here is a chart for "Expected Inflation", defined as 10-Yr Treasury minus 10-yr TIPS: https://crystalbull.com/stock-market-inflation/Expected-Inflation-chart/ That's what investors are pricing in for future inflation.
ReplyDeleteIf rates are negative, shouldn't we liquidate our investments and hold a huge party.
ReplyDeleteUSMV + TLT + SHYG will do the trick, choose weights based on risk aversion.
ReplyDeleteIf one is concerned with deflation, why pay someone to lend them money? deflation increases one's purchasing power. If one believes inflation will accelerate, then your advice is sound. With negative yields, are we waiting for Godot?
ReplyDeleteWell...if we are thinking in perpetuity...real interest rates (in general) have been falling for several hundred years (some say since 3000 bc).
ReplyDeleteMy amateur assessment is declining real rates of return on capital reflect greater wealth and income, and the ability of people/societies/nations to save, rather than living hand to mouth.
This suggests capital becomes less and less scarce.
Bond prices go up even more, in the long run?
John,
ReplyDeleteQuestions:
1. When TIPs were first introduced (January 1997), had Congress voted to authorize their sale?
2. If TIPs were not legislated into existence and defined to pay an inflation component equal the CPI or some other inflation measure, what stops the current or a future Congress from setting the inflation portion of TIPs to 0%? TIPs after all are a liability of the Congress (like any other government bond).
I have gone back through the federal register during 1996-1997 when TIPs were first introduced, and I cannot find any legislative measure that permitted their sale.
The Treasury's website gives no indication of a legislative measure
that permits them:
https://www.treasurydirect.gov/indiv/research/history/histtime/histtime_tips.htm
To me, TIPs are a sucker bet because their pricing does not reflect future potential Congressional action.
"You pay them 0.35% per year for a stable real value."
ReplyDeleteNot me, that's for sure.
But who? That seems to be the real question. Who has so much extra cash and so much need to park it that they will pay a premium for the privilege of just maintaining real value?
Furthermore, TIPS selling at such a premium as to creative negative yield reflects overwhelming demand. It's hard to see that demand as anything but a symptom of severe inflation.
Enjoy your blog and commentary. The TIPS yields have perplexed for a while but, I think there's a reason they've fallen so low.
ReplyDeleteFrom my understanding, TIPs actually protect against deflation as well. If the CPI falls, your principal adjusts downward until maturity. At maturity, if your principal is less than originally invested, the gov't simply gives your original amount back. So, given the uncertainty about whether the "demand shock" portion of Covid would induce deflation or if the "supply shock" component would induce inflation, I think investors are paying a premium for an asset that protects against potential changes in both directions and are bidding prices up.
For my money, given how high Debt/GDP, at some point deficits will matter. Which is easier, politicians pressuring the Fed to allow inflation to run above an average 2% (btw, I think inflation running above average inflation is really about inflating away some debt) or increasing taxes? Which is worse for the economy, increasing income and corporate taxes or the inflation tax? My opinion, the inflation tax is much worse but much more politically palatable.
Unknown,
Delete"Which is easier, politicians pressuring the Fed to allow inflation to run above an average 2% or increasing taxes?"
The easiest thing to do is for the Executive branch of government (Treasury Dept.) to sell equity in lieu of bonds. Then it doesn't matter what half baked solutions Congress comes up with.
"Which is worse for the economy, increasing income and corporate taxes or the inflation tax?"
Both are equally bad and are not the only options available.
Unknown,
ReplyDelete"From my understanding, TIPs actually protect against deflation as well. If the CPI falls, your principal adjusts downward until maturity. At maturity, if your principal is less than originally invested, the gov't simply gives your original amount back."
True enough, but at 30 years of negative returns (during a significant deflation) you are taking some pretty severe liquidity risk.
Notice that if were an insurance company and had to sell off the 30 year TIP prior to maturity in the secondary market to pay out insurance claims, you would would be taking a pretty hefty loss. The federal government may be willing to pay back full principle at maturity for TIPs during deflation, that doesn't mean the secondary markets are willing to do the same.
TIPS aren't huge in volume, despite being perhaps the only safe asset in the world in real terms. If demand increased, yields would go even more negative. It's a paradox that if you put your money into the "safe" asset, then you will eventually end up with almost no principal left (in real value), also having been able to spend nothing for the organization's purpose. The safest course is to spend 100% of the principal immediately on the organization's purposes, before either inflation or investment risk has had time to bite. (And, most important, before the trustees have had time to change and decide to spend the money on some novel purpose very possibly the exact opposite of what the donors intended.)
ReplyDeleteThough, if you're talking perpetuity, a revolution will probably come and wipe everything out within 500 years regardless of what you invest in. In 1500, what would have been a safe investment?