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There is an article discussing TIPs that is worth reading.
http://www.cxoadvisory.com/blog/external/blog12-17-09/


Do TIPS Work?

they conclude that:

* TIPS provide a good real-return hedge, despite CPI measurement error and possible demographic differences among TIPS investors. TIPS indexed to CPI are as good as TIPS indexed to other inflation measures, because inflation risk is largely independent of the measure used.
* TIPS better protect long-term, buy-and-hold investors than investors who hold TIPS for less than the full maturity. Over relatively short horizons, bond price volatility overwhelms the relatively small deviations between actual and expected inflation.
* The inflation rate implied by the difference in yields between nominal Treasury and TIPS markets are neither clean measures of expected future inflation nor likely to be good predictors of future inflation (see chart below).
* A "ladder" of TIPS, with maturities linked to anticipated expenditure timeframes, would help investors in or near retirement hedge against inflation in nominal expenses over time.
...
In summary, TIPS work reasonably well as an inflation hedge for long-term holders, but they are not particularly useful in measuring inflation expectations.



Rich
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Although the article doesn't mention it, the Chinese have recently begun to increase their purchase of TIPS. That increased demand in a relatively small market (relative to Treasuries) has increased the price of TIPS, decreasing their yield.

When the TIPS market was a sleepy, ignored corner of the bond universe, the inflation differential was more accurate.

Wendy
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I wonder why they would enter the TIPS market? Apparently they don't read this board and consider their price point very seriously.

jack
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<I wonder why they would enter the TIPS market? Apparently they don't read this board and consider their price point very seriously.>

The Chinese have invested billions of their trade surplus dollars in regular Treasury bonds. That helped force yields lower. However, the Chinese continued to buy Treasuries (among their many other investments, including commodity producers, internal infrastructure, etc.). They didn't seem very sensitive to the yield.

http://www.martincapital.com/chart-pgs/Pg_mmnry.htm

Within the past few months, the Chinese began to express concern about the huge amount of dollar monetary creation due to the crisis. They started to worry publicly about possible future inflation. It was in this small article that they announced their intention to buy TIPS.

The quantity of TIPS is much lower than Treasuries. Shortly after the Chinese announcement, the TIPS yield started to drop. I don't think this is a coincidence.

Many financial commentators have observed that the Chinese are fairly insensitive to yield.

Personally, I am disappointed by the entry of this 800 pound gorilla into the small TIPS market. I wish the rates would go back to their average of 2ish%.

http://research.stlouisfed.org/fred2/series/WFII10

I bought TIPS in December 2008 when the TIPS yield was higher than the Treasury yield (as if deflation would stick around for 10 years!). The TIPS I bought in December 2008 yield 6.3% (plus inflation). Talk about a panic!

Although I am disappointed about the low yield from TIPS, and I'm not buying right now, I still think that they are a better buy than Treasuries.

The 10Y Treasury yields 3.53%. The 10Y TIPS yields 1.24%. This is an implied 10 year inflation rate of 2.29%. That's pretty much the pre-crisis difference.

Is that reasonable? Will inflation over the next 10 years be only 2.3% per year?

That is a Macroeconomic question. A lot depends upon whether the U.S. falls into a Japan-like lengthy recession or recovers.

Wendy
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Wendy,

I bought TIPS in December 2008 when the TIPS yield was higher than the Treasury yield (as if deflation would stick around for 10 years!). The TIPS I bought in December 2008 yield 6.3% (plus inflation). Talk about a panic!

These are moments where I tend to push a lot of my chips into the center of the table because they don't come around very often. I might have to deal with a reinvestment issue 10 years later but that seems a small risk to manage in order to capture momentary market stupidity. This is why I'm not an orderly patterned buyer. I can garner average returns in many easy ways capitalizing on market farts is easy money.

jack
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Wendy

I think runaway inflation will come when I have given up and stopped expecting it as I have been expecting itevery year since 2001.

brucedoe
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