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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35343  
Subject: Re: SAFEHAVEN: Bondmarket Implosion! Date: 4/14/2004 8:57 PM
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"I disagree. If nominal rates rise because of inflation, then you're obviously right. But if real rates rise significantly - not a big stretch, especially since yields on the oldest ten-year TIPS maturing in 2007 are close to zero - then you will see the same sort of losses on TIPS that you see on regular bonds. If inflation isn't a problem but rates rise, then the inflation component won't make up for the difference. And with real rates so low, it wouldn't take as much of a move in real rates to create some big capital losses.

I guess the premise I take issue with is that in any interest rate move up, half of it is due to inflation. That has yet to be seen."

Dan,

I don't think we disagree, though we may be talking past each other. I was using the half-interest rate climb as inflation as an example. Of course, there is no way of knowing if that will happen. Perhaps interest rate increases would be purely nominal, in which case TIPS would do just fine. Or it could be all real rates. I would guess somewhere in between would be most likely, in which case, regular treasuries would be harder hit by rate increases than equivalent maturity TIPS.

But the point about protection at the bottom does hold—the fixed rate of TIPS can't go below zero. I tried, not long ago, to take a stab at what Vanguard's fund holdings were in terms of fixed rate component and maturities. It's guesswork (which is why they, themselves, won't hazard guesses on what durations on the fund really are). But I really can't see how we could be dealing with more than 3% fixed rate on average duration of 10 years, even with the TIPS bought before 2001 (remember, a lot of money has flooded into TIPS since then), which would mean a maximum drop in the fund's NAV of 30%, and I think that's pushing it. Not good, but better than what would happen to their Intermediate and Long term treasury funds if rates skyrocket.
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