2024 Returns on TIPS

Treasurys Outperform TIPS in Strong, Broad-Based Market Rally.

Treasury Inflation-Protected Securities (TIPS) posted an average gain of 4.1% in the 2024 third quarter, below the 4.8% average gain on comparable maturity straight Treasury securities.  The return on TIPS was composed of an estimated average price gain of 320 basis points (bp), interest income of 60 bp and an inflation adjustment of 30 bp.

Treasuries outperformed TIPS across all maturities.  The degree of outperformance was comparable across all maturities.  Treasurys outperformed TIPS by 68 bp on the short end, 86 bp in the intermediates and 84 bp on the long maturities, according to my calculations.

The average TIPS yield ended the quarter at 1.90%, down 43 basis points (bp) from 2.33% at the end of the 2024 second quarter.  The average TIPS yield fell 45 bp in the short maturities; 50 bp in the intermediates and 29 bp in the long maturities.  Average straight Treasury yields ended the quarter at 3.82%, down 73 bp from 4.55% in 24Q2.  Short-maturity Treasury yields fell 97 bp, intermediates 68 bp and long maturities 41 bp.  With the changes in relative yields, the breakeven spread declined by 30 bp to 192 bp at September 30 from 222 bp at June 28.

As noted, the CPI inflation adjustment fell to just 30 bp.  This reflected the steady slowing in inflation over the past few months.  Price gains therefore drove TIPS  returns.  TIPS benefited from the general decline in interest rates, but not as much as comparable maturity straight Treasurys.

TIPS yields decreased by 29 bp on average from the 2040 maturities on out in 24Q3 vs. 24Q2.  Short-term yields fell 45 bp, but yields rose on the very short end of the curve, which is much more sensitive to near-term inflation expectations.  As inflation expectations moderated, short maturity TIPS investors required higher yields to compensate, as shown in the chart on the next page.

The downshifting of the Treasury yield curve was much more pronounced than the TIPS yield curve.  Straight Treasury yields, as noted, fell by 73 bp, reversing the 24Q2’s 11 bp increase.

The quarterly U.S. Treasury yield curve chart shown below highlights the sharp drop in yields that occurred during 24Q3.  Declines in yields were most pronounced in the short and intermediate maturities; but the more modest drop in long-term yields still produced higher returns.

The quarterly TIPS adjustment was 0.3% in 24Q2, a sharp decline from the 1.7% increase in 24Q2, but on par with 24Q1’s 0.2% increase.  The easing of inflation was driven mostly by falling energy costs and by declines in commodity costs (excluding energy commodities).  Cost increases in most other CPI categories also slowed.  Shelter costs have eased a little, but they remain persistently and surprisingly high.

Falling inflation helped prime the Fed’s 50 bp cut in the target Fed Funds rate in September.  That was the catalyst behind the recent sharp rallies in Treasurys and TIPS.  The financial markets are expecting additional cuts of 25 bp at each of the next two FOMC meetings in early November and mid-December.  If they get them, those declines are unlikely to move the markets nearly as much as the Fed’s 50 bp surprise in September.

The price of oil has rebounded modestly as a result of the conflicts in the Middle East.  The sub-2% annualized three month change in inflation that we have seen over the past two months is unsustainable, in my view.  TIPS breakeven spreads are now back to their long-term averages, a sign of reduced inflation expectations.  But the median CPI and PCE, which are equal weighted measures of the changes in all goods and services in the CPI and PCE baskets as calculated by the Cleveland Fed, are still running over 4% and 3%, respectively, above the Fed’s 2% target.  This suggests that inflation is still bubbling under the surface.  Treasurys seem due for a correction after the recent rally.  As a result, the breakeven spread is likely to increase over time, probably as a result of a faster increase in Treasury yields (vs. TIPS).  To my eye, TIPS are probably the better buy at this time.