TIPS and Inflation

Bailouts, bailouts and more bailouts. How much money is getting pumped into the economy? Trillions and trillions. (I'll try to find some good numbers on this.) Will this result in more inflation? Absolutely.

When? Ah, there's the hard part. For now, inflation is still the biggest risk as the price of everything from oil to plasma TVs is collapsing.

In the meantime, what should we do about it? Well, TIPS (Treasury Inflation Protected Securities) are the traditional way of protecting a fixed-income portfolio from inflation. Now, Treasury yields are at historic lows, so this probably isn't a good time to buy, but let's run the numbers now and then keep an eye out when things turn. (How bad of a time is it to buy Treasuries? The government recently auctioned some Treasury bills for 0%. That's right, zero. People were actually ready to pay the government to look after their money.)

TIPS pay interest every six months. The catch is, every six months, the government adjusts up the principal value of the debt based on the CPI. So although TIPS will yield a fixed interest rate, the principal amount will change based on inflation. So far so good.

Now, when is a good time to buy? Well, 10-years TIPS are yielding about 2.4%. Meanwhile, the regular 10-year Treasury bond is yielding 2.65%. We can't directly calculate that expected inflation is only 0.25%, but, we can safely say that the market is expecting inflation over the next ten years to be less than 1%. That I don't believe, and therefore wouldn't be a buyer of TIPS right now (or of Treasuries, for that matter).

Now if I were a hedge fund, I'd think about buying TIPS and shorting Treasuries, or just shorting Treasuries outright. I'm not a hedge fund guy, and I won't, but it's an interesting thought. But for now, it's time to sit tight.