- TIPS are Treasury bonds created to protect investors against inflation risk. They pay a fixed coupon; however, the dollar amount of the interest payment goes up and down according to changes in inflation (CPI Index) as the principal it is adjusted accordingly.
- TIPS are indexed for inflation, and thus offer low inflation risk. Deflation may cause the price of these securities to fall. However, if held until maturity, TIPS will always return either the inflation-adjusted principal or the par value at maturity of the bond, whatever it is higher. Therefore, there is a natural deflation protection embedded in the structure of the bond.
- the value of TIPS is affected more by expectations in inflation changes rather than the actual movement of inflation.
- The volatility caused by the Covid-19 pandemic this year creates a perfect opportunity to understand what are the main drivers underpinning TIPS’ prices. In March, TIPS yields shot higher as inflation expectations in the short-term fell. This was mainly due to a drop in energy prices and the expectation that social distancing measures would also drive consumer prices lower. Lower inflation expectations also provoked an inversion of the TIPS yield curve in March (in yellow). However, as the economy reopens and activities resume, we see the US TIPS yield curve normalizing (in green).
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.