Today’s TIPS auction came in negative for the first time ever, with 5-year TIPS yielding negative 0.55%.TIPS are Treasury Inflation Protected Securities. The idea is you buy this version of a Treasury and it is hedged against inflation, with the CPI as the judge.
It would seem that a negative TIPS number means deflation in the short term. But that’s not quite true.
What it means is that investors are betting the principal paid out in five years will rise because inflation rises. They’re willing to accept 5-years of negative interest payments (once every 6 months) to get a higher principal 5-years later.
This is a product of regular 5-year treasuries having negative real yields. The yields on those treasuries are so low, that they are less than CPI. That means investors are losing money on that investment. So TIPS provide a way to get in on future inflation, and get a final payout linked to that bet.
This is a two way bet on the Fed’s actions:
- First, that the Fed (or the real economy) can create inflation
- Second, that through QE 2, the Fed is going to enter in and buy treasuries, distorting the market, and make TIPS more valuable by reducing the yield on regular 5-year treasuries.
In a deflationary environment, TIPS will see declining interest payments, but maintain their final coupon value. So it is possible that some investors may prefer the government to hold their money, and get that same payout in the end. But they could just hold cash in such an environment, so that doesn’t make much sense.