28 Sep Treasury Inflation Protected Securities (TIPS)

What are they?

Treasury Inflation‐Protected Securities (TIPS) are securities issued by the US Government whose principal is adjusted monthly by changes in the Consumer Price Index (CPI‐U). If CPI increases (inflation), principal increases. Conversely, if CPI falls (deflation), principal decreases. This mechanism ensures the value of these bonds is not affected by actual measured inflation. TIPS are issued with maturities of 5, 10 and 30 years.

How they pay

The direct relationship between TIPS and the Consumer Price Index affects both the principal value and the amount of interest paid every six months. TIPS pay interest at a fixed rate. Because the rate is applied to the adjusted principal, interest payments can vary in amount from one period to the next. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases. At maturity, a TIPS investor receives the adjusted principal or par ($100), whichever is greater.

When to Use TIPS

TIPS are often used as a measure of inflation expectations. The yield difference between a traditional Treasury bond and an equivalent maturity TIPS reflects those expectations. TIPS will outperform traditional Treasury securities if realized inflation exceeds the inflation expectations embedded in the TIPS price.