Latest / Inflation and Your Money with Fexingo: Protecting Purchasing Power and Beating Inflation / How TIPS Are Beating the Inflation Slowdown
Transcript
- Lucas: So the May CPI number came in at 334.0, up from 332.41 in April. That's a 0.48 percent monthly increase — not catastrophic, but it's the second straight month of acceleration after what looked like a cooling trend earlier this year. Luna: And core CPI, excluding food and energy, went to 336.1 from 335.42. So the stickiness is real. Lucas: Exactly. And you'd think that would send everyone running to inflation hedges. But gold's been a mess — it's at 4,344, up 6.2 percent in five days, but that's after a rough few weeks. Silver's been the real performer, up 9.2 percent in the same window. Luna: But you've been looking at something else. TIPS. Lucas: Yeah, Treasury Inflation-Protected Securities. They're having a moment. And I think they're actually a cleaner hedge than commodities right now, for a specific reason. Luna: Alright, walk me through it. Because I think a lot of listeners hear 'TIPS' and either think they're too complicated or assume the yields are just too low. Lucas: So the basic mechanism: a TIPS bond's principal adjusts with inflation, measured by CPI. If inflation goes up, the principal goes up, and your interest payment — which is a fixed percentage of that principal — goes up too. When the bond matures, you get the inflation-adjusted principal or the original principal, whichever is higher. Luna: So you're not just betting that inflation stays high — you're locking in a real return above whatever CPI does. Lucas: Right. The current yield on the 10-year TIPS is about 1.9 percent real. That means if inflation averages 2.5 percent over the next decade, your nominal return is roughly 4.4 percent. Compare that to the 10-year nominal Treasury at around 4.2 percent — you're basically breaking even on the inflation expectation, but with a floor. Luna: But the breakeven inflation rate — the market's implied expectation — is at 2.32 percent right now, based on the difference between nominal and TIPS yields. So the market is pricing in that inflation will average 2.32 percent. If you think it'll be higher, TIPS are cheap. Lucas: Bingo. And given that CPI came in at 334.0, and core is still sticky, I think there's a decent case that the breakeven is a bit low. The Fed's rate is paused at 3.62 percent, and they're not cutting anytime soon because the data isn't cooperating. So real rates — the nominal rate minus inflation — are actually positive but not high enough to crush demand. Luna: Let me play devil's advocate. TIPS have a tax problem. The inflation adjustment to principal is taxable as income in the year it accrues, even though you don't get that cash until maturity. So in a taxable account, you can get a phantom tax bill. Lucas: That's the biggest knock against them, no question. If you're in a high tax bracket, the after-tax real yield can turn negative if inflation spikes. That's why TIPS really shine in tax-advantaged accounts like IRAs or 401s, where the tax deferral solves that problem. Luna: Okay, so for someone with a taxable brokerage account, what's the alternative? Lucas: You could look at I Bonds — Series I Savings Bonds — which also adjust for inflation but defer the tax until you cash them. But there's a $10,000 annual purchase limit per person. So for larger allocations, TIPS in an IRA is the way to go. Luna: And the TIPS ETF space is huge now. The biggest one, iShares TIPS Bond ETF, TIP, has over $30 billion in assets. Lucas: Right, and the expense ratios are low — like 0.19 percent. So you can get diversified exposure without building a ladder of individual bonds. But I'd argue that if you're serious about the inflation hedge, buying individual TIPS at auction gives you more control over maturity and coupon. Luna: Let's talk about the maturity choice. The 5-year TIPS real yield is around 2.1 percent, the 10-year is 1.9, the 30-year is 2.0. The curve is pretty flat. Lucas: Yeah, the curve is basically telling you the market expects inflation to be elevated for the next few years and then moderate. So the 5-year gives you the highest real yield right now, but you're taking more reinvestment risk. The 10-year locks in a decent real yield for longer. If you think inflation stays sticky for a while, the 5-year might be better because you can reinvest at potentially higher rates later. Luna: But if inflation surprises to the downside, TIPS will underperform nominal Treasuries. So it's a bet. Lucas: Everything is a bet. But the key here is that with the breakeven at 2.32 percent and CPI running above 3 percent year-over-year, the market is pricing in a fairly aggressive disinflation. If that doesn't happen — and the last two CPI reports suggest it might not — TIPS are cheap. Luna: So for the listener who's been sitting in cash earning 3.6 percent in a money market fund, what's the move? Lucas: I'd say start moving some of that cash into a short-term TIPS ETF, like the Vanguard Short-Term Inflation-Protected Securities ETF, VTIP, which has a duration of about 2.5 years. You're getting a real yield of about 1.5 percent there, plus the inflation adjustment. That's a lot better than the negative real return on cash right now. Luna: And the Fed's not cutting — the daily effective rate is still 3.62 percent — so cash isn't going to get more attractive anytime soon. Lucas: Exactly. The Fed is stuck. The labor market is still tight, services inflation is sticky, and the next move is likely a cut, but not until late this year or early next year. So you have this window where real yields on TIPS are positive and inflation is still above target. It's a sweet spot. Luna: Alright, so one concrete takeaway: if you have a long-term portfolio and you're worried about inflation, consider allocating 5 to 10 percent to TIPS, preferably in a tax-advantaged account. Lucas: I think that's a solid range. And don't just buy and forget — rebalance when the breakeven gets too high or too low. When the breakeven is above 2.5 percent, TIPS are expensive relative to nominal bonds. When it's below 2 percent, they're cheap. Right now at 2.32, we're in the middle, but trending toward cheap given the CPI data. Luna: That's a nice framework. Breakeven as a valuation signal. Lucas: Yeah. And honestly, if today's conversation helped you think about that decision differently — maybe you've been sitting on cash and wondering what to do — that's the kind of thing we love hearing. If it was worth a coffee to you, there's a link: buy me a coffee dot com slash fexingo. Just a small way to keep the show ad-free and independent. Luna: Absolutely. We don't do ads, we don't have sponsors pushing products. Listener support is what keeps this going. Lucas: Alright, back to TIPS. One more nuance: the liquidity premium. TIPS are less liquid than nominal Treasuries, so during market stress, their prices can diverge from fair value. That creates opportunities. Luna: Like in March 2020, when TIPS got hammered as investors sold everything for cash. Lucas: Exactly. If you can stomach that volatility, buying TIPS during a liquidity crunch can give you outsized returns when the market normalizes. The real yield on the 10-year TIPS spiked to nearly 1 percent in March 2020, which was a screaming buy. Luna: So the playbook is: accumulate during panic, hold during calm, and rebalance based on breakeven levels. Lucas: That's the disciplined approach. And with CPI still sticky, the Fed on hold, and the breakeven not pricing in a lot of inflation risk, TIPS deserve a spot in most portfolios right now. Luna: Alright, good stuff. Next episode we'll dive into how inflation is affecting municipal bonds — because that's a whole other can of worms. Lucas: It really is. See you next time.