We’ve had questions on why Treasury Inflation Protected ETFs (TIPS) were down YTD while inflation isn’t really budging. We wanted to provide some color on the topic given the big moves in interest rates and the ongoing debate about inflation.


Funds such as SCHP/TIP own actual TIPS and track their performance. Despite all of the ongoing chatter about inflation and quasi hysteria in the media about the Fed falling behind the curve in recent months, the bond market (being the smart market that it is) has been pricing in inflation since the start of 2019. The trend accelerated coming out of the initial pandemic shock given all the stimulus money being pumped into the economy, and that sent 5-Yr TIPS yields decidedly negative, pushing – 2.00% at the lows.


Since the economy began to stabilize in early 2021 and investors started to see the light at the end of the “COVID tunnel,” 5-Yr TIPS yields turned sideways (still in very negative territory) as investors remained concerned about inflation, thinking that the Fed was likely falling behind the curve given the rocky and uneven recovery in the labor market. As a result, real rates chopped sideways in very negative territory for much of 2021 while nominal rates steadily climbed higher. This resulted in market- based inflation expectations via 5-Yr breakeven to rise, peaking at just over 3% in November. Once the Fed took a more hawkish pivot in December, however, 5-Yr TIPS yields began to climb and recently reached new one- year highs as the market gained confidence that the Fed would, and could, control inflation given the hawkish shift in tone. Underscoring that point, the 5-Yr Breakeven inflation rate has pulled back by 40-50 basis points to the mid-2.70% zone, which is still above the Fed’s target but notably below the highs.


 5-yr Real Yields. Source. Bloomberg LP. As of 2/4/21.


So, over the last month, the market has actually become less concerned with the Fed’s ability to control inflation which led to profit taking in inflation protected investments and a rise in TIPS yields, hence the negative YTD return for funds such as VTIP. The chart above offers a good visual of the 5-Yr TIPS yield with the yellow square encompassing the increased demand for inflation protection via TIPS beginning in 2019 while the red square shows the recent profit taking and the market’s vote of confidence that the Fed will be successful in containing inflation.


It’s also worth noting that TIPS are longer duration vehicles, so they have been double-whacked by real yields rising (especially on the front end) and long end rates moving upward.

Source. Bloomberg LP. As of 2/4/21.





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