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As seen in the linear red trend line, the 5-Year TIPS real rate averaged roughly 1.5% over the past 7 years. It's now less than 0.5%. You will note that the slope of the trend line is neither heading down nor heading up. It is rock steady.
Why are we so far below the trend line? One might argue that it is different this time.
That argument comes up a bit short though. What's different? Over the past 7 years we've seen just about every sort of economic environment there is. We've seen stock market euphoria as the DJIA breached 14,000+. We've seen inflation fears as oil breached $145+. We've seen deflation fears as the housing market, the stock market, and the commodity/energy markets crashed. So what could possibly be different this time?
Even deflationary Japan has fairly decent real interest rates (mostly due to the deflation). So why don't we?
Some would argue that all this new debt we're taking on is ultimately inflationary. Here's another argument though. What happens if the supply of debt someday exceeds the demand? Was subprime debt ever known for its low interest rates? These interest rates are clearly VERY low. So what happens if the world ever thinks of us as subprime?
Buyer beware. I really don't think it is different this time. It will be especially not different this time if we actually experience another deflationary event. Check out those 4% real yields in the chart.
ETF Assets Drop in January
Fixed income, most notably TIPS, or Treasury Inflation-Protected Securities, and one- to three-year bonds, led the asset surge into ETFs last year, taking in more than $200 billion through the first 11 months of 2009.
That just figures. Keep piling in. Get used to disappointment though. It makes no sense to lock in real yields this low for a solid 5 years. Even if investors are right and inflation does take off, then 0.5% real yields are a lousy defense. If inflation averages 5% then you'd only be earning 5.5%. After taxes, you'd most likely be losing money.
Let's say the economy continues to stink in 5 years. Then what? Reinvest into more money-losing short-term TIPS? Is that the long-term plan?
I may be certifiably insane, but I'm actually going to be buying some 30-Year TIPS in this month's auction. The yield curve is very steep. It's steep for a reason. It's to help the banks borrow short and lend long. Well, I'll take some of that help too. The real yield should be at least 2% in the auction. I'll be buying and holding until maturity. It's plenty good enough for me.
I won't be protected from serious hyperinflation or outright default, but at least I'll be protected from the slow endless grind of lousy real yields. Just picture the stock market over the last decade if you need a visual.
This is not investment advice. I'm just saying what I am doing and why I am doing it. I see little to no value in short-term TIPS. For the life of me, I just can't see how others do.
See Also:
Trend Line Disclaimer
Source Data:
FRB: Selected Interest Rates
2 comments:
Stag,
It's scary how often we are on the same wave length. When you made this post yesterday, I had just been mulling over the real yields of short duration TIPS. Imo, for a taxable account anyway, a TIP fund with a short duration doesn't make much sense here in either an inflationary or deflationary environment. Then again, it's difficult to make sense of anything right now.
Like you, I think China is on the brink. I expect a reverse China Syndrome. China's impending credit meltdown will make a B-line through the earth and kick off the next leg down here.
Can you believe our debt is supported by China's debt? And China's debt is supported by massively over-valued real estate? And massively over-valued Chinese real estate is supported by ~ $1/hr Chinese wages!
They say a chain is only as strong as its weakest link. With that in mind, I still think the system is more unstable than ever. The eCONomy has tanked yet the trillions in unpayable debts remain.
http://en.wikipedia.org/wiki/China_Syndrome
mab,
"It's scary how often we are on the same wave length."
Had I been a deflationist from the start I think we would have always been on the same wave length.
As you know, I turned bearish in 2004. I would have never guessed that the deflationists AND the stagflationists would have both done well over the past 6 years.
I don't think that will be true into the future, but who really knows?
I can say that I like the deflationist side of the fence more and more with each passing China article.
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