2024 Returns on TIPS

TIPS Outperform Treasurys as Market Ebbs and Flows, Even as Inflation Recedes.

Treasury Inflation-Protected Securities (TIPS) posted an average gain of 0.8% in the 2024 second quarter, slightly better than the 0.3% average gain on comparable maturity straight Treasury securities.  The return on TIPS was composed of an estimated average price loss of 125 basis points (bp), which was more than offset by interest income of 40 bp and an inflation adjustment of 165 bp.

TIPS outperformed Treasuries across all maturities.  The degree of outperformance was comparable across the short- to intermediate maturities, but greater in the long maturities (i.e. a smaller loss).  The positive differential was 44 bp on the short end, 39 bp in the intermediates and 81 bp on the long , according to my calculations.

The average TIPS yield ended the quarter at 2.33%, up 43 basis points (bp) from 1.90% at the end of the 2024 first quarter.  The average TIPS yield rose 79 bp on average in the short maturities; 19 bp in the intermediates and 12 bp in the long maturities.  Average straight Treasury yields ended the quarter at 4.55%, up 11 bp from 4.44% in 24Q1. With the change in yields, the breakeven spread declined by 32 bp to 222 bp at June 28 from 254 bp at March 28.

The inflation adjustment made all the difference for TIPS in the quarter.  Without it, TIPS would have underperformed straight Treasurys, as the increase in TIPS yields was greater than comparable maturity straight Treasurys.  This reflected the uptick in inflation that we saw during the early months of the quarter, but by the end of the quarter, inflation was receding.  As a result, investors sought higher yields from TIPS, as they anticipate that inflation will remain subdued in the coming months.

TIPS yields increased about 15 bp on average from the 2027 maturities on out in 24Q2 vs. 24Q1.  The shift in the short end of the curve, which is much more sensitive to near-term inflation expectations, was meaningfully higher, up 79 bp.

The upshifting of the Treasury yield curve was less pronounced than the TIPS yield curve.  Straight Treasury yields, as noted, rose by 11 bp during 24Q2, less than the 40 bp increase in 24Q1.

The quarterly U.S. Treasury yield curve chart shown below shows that yields have risen steadily throughout the year, but at a slower rate in 24Q2.  In fact, the Treasury market has experienced a couple of selling “waves,” which took the 10-year yield (for example) up from 3.95% at the end of 2023 to a peak of 4.33% near the end of-February, back down to 4.20% at the end of March, and then to the peak (so far this year) of 4.70% near the end of April, before easing to 4.36% at the end of June.

The quarterly TIPS adjustment was 1.7% in 24Q2, up from 0.2% in 24Q1.  This year’s modest resurgence in inflation was caused mostly by rising energy costs combined with persistently high shelter cost inflation.  Energy costs had retreated after peaking in early April, but they rose steadily during June from  their beginning of the month lows.  Given the dynamics of the energy market and high geopolitical risks, such volatility may very well persist.

On top of this, the developing weakness in many sectors of the U.S. economy, though generally positive for taming inflation, may also push businesses to grab for price whenever they can to preserve profitability.  One notable area of potential disruption is in shipping, where terrorists attacks near the Suez canal and a drought in Panama have forced rerouting, adding days and costs to deliveries, even though consumer demand has receded from recent peak levels.  So far, these disruptions are not as severe as in 2022-2023, when trains and trucks were still operating below pre-COVID levels amidst the surge in U.S. consumer spending from Federal government stimulus.

Shelter costs have also been an important contributor to inflation, but housing costs for owners and renters should begin to moderate soon, given the softness in housing sales and excess supply in multi-family.

In this environment, exogenous shocks are an ever-present risk.  Otherwise, inflation should continue to recede.  With breakeven spreads not that far off their long-term averages, the prospects for TIPS and U.S. Treasurys seem more balanced, in my view, with perhaps a slight short-term tilt in favor of straight Treasurys.