2024 Returns on TIPS

24Q4 Results: Treasurys Slightly Outperform TIPS with Both Posting Moderate Losses.

Treasury Inflation-Protected Securities (TIPS) posted an average loss of 3.8% in the 2024 fourth quarter, better than the 4.1% average loss on comparable maturity straight Treasury securities.  The return on TIPS was composed of an estimated average price loss of 450 basis points (bp), interest income of 45 bp and an inflation adjustment of 35 bp.

TIPS outperformed Treasurys in the short- and intermediate maturities, but suffered comparable percentage losses in the longer maturities. The relative performance difference for TIPS was +56 bp on the short end, +44 bp in the intermediates and –9 bp on the long maturities, according to my calculations.

The average TIPS yield ended the quarter at 2.19%, up 29 basis points (bp) from 1.90% at the end of the 2024 third quarter.  TIPS yields fell 7 bp in the short maturities, but rose 56 bp in the intermediates and 54 bp in the long maturities.  Average straight Treasury yields ended the quarter at 4.45%, up 63 bp from 3.82% in 24Q3.  Short-maturity Treasury yields rose 52 bp, intermediates 78 bp and long maturities 63 bp.  With the changes in relative yields, the breakeven spread rose by 34 bp to 226 bp at December 31 from 192 bp at September 30.

As noted, the CPI inflation adjustment was just 35 bp.  This reflected the slower pace of inflation over the past few months.  Price gains therefore drove TIPS losses.  TIPS suffered from the increase in interest rates, but not quite as much as comparable maturity straight Treasurys.

As noted, TIPS yields increased by 29 bp on average.  The TIPS yield curve shifted upward in the intermediate and long-term maturities, ending the year about 40 bp above beginning year levels.  The rise in yields came mostly at year end, driven by expectations that the FOMC would keep interest rates higher for longer; but breakeven spreads also rose, signaling slightly higher inflation expectations.

The reshaping of the Treasury yield curve was much more pronounced than the TIPS yield curve.  During the course of the year, the Treasury yield curve shifted from downward sloping to upward sloping, with the two-year yield serving as the fulcrum at around the 4.25% level.  The 100 bp drop in the Fed Funds target rate pushed the short end of the curve lower; while expectations of a slower pace of rate cuts by year end helped pulled longer term yields higher.  The yield curve shifted from relatively flat in November to more clearly upward sloping in December, a sign perhaps of reduced concerns about the likelihood of a recession.

The quarterly TIPS adjustment was 0.4% in 24Q4, slightly higher than 24Q3’s 0.3% increase.  The total TIPS adjustment was 2.6% in 2024, down from 3.2% in 2023 and 7.5% in 2022.  The latest Survey of Professional Forecasters from the Philadelphia FRB anticipates that headline CPI inflation will slow further to 2.3% in 2025 and then to 2.2% in 2026, both essentially in line with current breakeven spreads.

While there is some concern about the possibility of an increase in inflation if the incoming Trump administration follows through with its threats to raise tariffs and deport undocumented immigrants, it seems more likely that the modest consensus inflation forecasts will be realized, as the pace of employment growth and economic activity slows.  Consequently, there is room, I believe, for interest rates to head lower in 2025, perhaps by more than current expectations of two 25 bp Fed Funds target rate cuts.  If so, both TIPS and straight Treasurys should earn positive returns in 2025, with greater total return potential across the longer maturities, as the yield curve flattens.