TIPS Under Perform Treasurys in the 2025 Fourth Quarter As Inflation Expectations Appear to Ease
Treasury Inflation-Protected Securities (TIPS) posted an average loss of 0.3% in the 2025 fourth quarter, underperforming the 0.5% average gain on comparable maturity straight Treasurys. The return on TIPS was composed of an estimated price decline of 116 basis points (bp), partially offset by interest income of 37 bp and an inflation adjustment of 44 bp.
TIPS underperformed Treasury performance across all maturities. The relative performance difference for TIPS was -50 bp in the short maturities, -120 bp in the intermediates and -80 bp on the long maturities, according to my calculations.
The average TIPS yield ended the quarter at 2.08%, up 51 basis points (bp) from 1.57% at the end of the 2025 third quarter. TIPS yields rose 102 bp in the short maturities, 16 bp in the intermediates and 14 bp in the long maturities. Average straight Treasury yields ended the quarter at 4.01%, down 4 bp from 4.05% in 25Q3. Short-maturity Treasury yields declined 18 bp, intermediates eased 2 bp and long maturities rose by 9 bp. With these relative yield changes, the average breakeven spread decreased by 56 bp from 249 bp at September 30 to 193 bp at December 31. The decrease in spreads was most pronounced in the short maturities, where the average spread fell by 119 bp. Intermediate spreads declined 18 bp and long maturity spreads decreased 4 bp.
The CPI inflation adjustment was 44 bp, down from 70 bp in 25Q3, as headline inflation was estimated to have eased slightly. Since the inflation adjustment is calculated on a daily basis, Treasury Dept. had to impute the CPI for the month of October because no CPI report was issued for that month due to the Federal government shutdown. As a result, the Treasury Dept. appears to have applied the same monthly increase for October – 0.25% – as was reported for September. Thus, the monthly change in CPI for November was imputed to be -0.46%, after the BLS resumed publication of the report.
For all of 2025, TIPS delivered a total return of 5.8%, better than the 5.3% return on comparable maturity straight Treasurys.
As noted, TIPS yields rose by 50 bp on average. The TIPS yield curve shifted upward across short and intermediate maturities in 25Q4. Long-term TIPS yields rose by 9 bp, as shown in the chart below. Long yields are now higher than they were at the end of 2024.
Since the end of 2024, the straight Treasury yield curve has shifted downward, but yields of 20- and 30-year maturities have barely budged. In 25Q4, short term yields dropped as the Fed eased, but long-term yields increased slightly. The sag in the belly of the Treasury yield curve eased in December with the decline in short-term yields. The yield curve is now clearly upward sloping, which is usually positive for the economy since most small- and medium-sized businesses borrow at floating rates that are tied to short-term yields. Even so, the drop in yields out to the two-year maturities suggests perhaps that a modest slowing in the economy may occur in 2026.
The quarterly TIPS inflation adjustment was 0.44% in 25Q4, down from 0.70% in 25Q3. The decline in the inflation adjustment sparked selling in short-maturity TIPS. Looking ahead, factors such as tariffs, fluctuations in the dollar, and other variables continue to create uncertainty around future inflation rates.
The breakeven rate or spread, a measure of inflation expectations, declined 56 bp in 25Q4, dropping from 249 bp to 193 bp. The decrease was greatest across the short maturities, where spreads fell by 119 bp to 145 bp. Intermediate spreads declined by 18 bp to 224 bp. Long-term spreads decreased by 4 bp to 229 bp.
The TIPS data as reported by the WSJ contained an error in the adjusted principal, whereby the actual accrued principal for the 1.625% TIPS due April 2030 was instead assigned to the 2.375% TIPS due February 2055 and all of the remaining figures were pushed up by one notch in the data table. So, for example, the accrued principal for the 1.625% TIPS due April 2030 was reported as 1269, which is the amount of accrued principal attributable to the 0.125% TIPS due July 30. I have corrected this error and checked it with the actual amounts reported on treasurydirect.gov. I believe that all of the other amounts (i.e. bid and ask prices for each TIP issue) are correct, primarily because they produce a pattern of yields and returns that is consistent with the patterns in previous periods.
It is especially difficult, I believe, to assess the prospects for TIPS in 2026 and beyond. For one, Fed Chair Powell is due to step down in May and his replacement is likely to support President Trump’s push for lower interest rates. If that happens, policy rates would decline, but it is difficult to predict how the bond market will react, with the possibility that performance could vary across maturities. All of this will play out while Federal government deficits remain unsustainably high, which raises the probability that long-term yields will eventually go higher, even if short-term yields remain low.
Furthermore, it is difficult to know what impact this will have on the economy, including the labor market. Consumers will get a boost in income from certain provisions in the One Big Beautiful Bill Act, so overall economic activity may hold up reasonably well in the short term, but businesses are likely to be more cautious about adding jobs. A growing divergence in the economic prospects of upper income households vs. lower income households could spark pockets of dislocation in certain sectors and geographies.
Then there is the prospect of so-called black swan events, including the possibility of geopolitical conflict, disruptive political disputes at home, the mid-term elections and the consequences of tariffs and tariff negotiations.
For now, the most likely scenario seems to be the middle ground, where the economy could show some surprising near-term resilience, but probably just muddle through in the medium-term. It is almost certain, however, that some other scenario will unfold. Predicting which one is beyond my expertise.
From a historical perspective, the current breakeven spread on TIPS is close to the long-term average, while TIPS and straight Treasury yields are in the top half of their long-term historical ranges. This suggests that investors are requiring higher yields to compensate for risk. Accordingly, without a reduction in perceived risk, bonds (including TIPS) seem likely to generate only modest returns, mostly from interest income rather than price appreciation. Even with the likelihood of further declines in the Fed Funds target rate, it would be surprising indeed if TIPS and Treasurys were to deliver superior returns for all of 2026 and beyond.
January 6, 2026
Stephen P. Percoco
Lark Research
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© 2015-2026 by Stephen P. Percoco, Lark Research. All rights reserved.
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