TIPS and Deflation

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JackA

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Does anyone know where I can find information regarding the prices of TIPS and the inflation (or deflation) rates implied by that pricing?
 
Inflation expectations are just the differnce in yields between TIPS and nominal treasuries. You can bootstrap it and get whatever expectation you want. TIPS and treasury yields are everywhere.
 
So with the 5-year TIPS yielding 1.5% and 5-year Treasuries yielding 1.6%, the market is implying an inflation rate of -0.10% per year over the next 5 years.
Is this the correct way to interpert this?
 
Which way does it work again? I think it’s:
Nominal treasury yield = real RFR + premium for expected inflation
TIPS yield = real RFR
So….
Expected inflation = Nom yield - TIPS yield
(assumes equal maturities; probably needs to be a spot rate too)
Is that right? or did I get the subtraction backwards?
 
Treasury yield - TIPs yield = inflation expectation
-good point bchadwick on making sure you have equal maturities. You can use the most recent auction results at treasurydirect (I just worked on this yesterday).
 
So according to the rates on the 5-year Treasuries and TIPS, the market is pricing in a negative inflation rate of -0.10%, annually, over the next 5-years….a deflationary enviroment.
 
Sounds right… I haven’t done the numbers myself, but everyone is saying that TIPS is pricing in deflation.
 
wouldnt that be an inflation expectation of .10% then
 
bchadwick Wrote:
——————————————————-
> Sounds right… I haven’t done the numbers myself,
> but everyone is saying that TIPS is pricing in
> deflation.
It’s been implying deflation since July.
 
Are the yields given above correct? If so, it looks to me like TIPs are pricing in inflation.
In theory, at maturity, both TIPs and normal treasuries should be worth the same. The actual principal amount on TIPs gets adjusted for inflation semi-annually based on the CPI.
So if the treasury is yielding more than the inflation protected treasury, you would expect to see the principal amount of the inflation protected security rise, hence inflation. If the TIP were yielding more than the treasury you would expect the principal to fall, hence deflation. Because the TIP is paying less than the treasury I believe this implies that the principal of the tip will increase, or inflation will occur.
If this isn’t correct please tell me where my logic, or understanding of how TIPs work, is flawed.
 
check out the constant maturity treasuries data in FRB statistical release H.15
you can take any desired maturity of TIPS (5, 10, 20) and same maturity treasury, and back out the inflation expectations over that horizon.
if you want to bootstrap this years expectations, i think you will need to use a TIPS that matures in 1 year, and a similar treasury, and calc it. then you do same thing for 2 years out, 3 years out, etc. and start bootstrapping each individual year. but just working with the 5 10 20 numbers should give you a sense for general expectations.
keep in mind there are technical factors which may skew data.
i for one am intrigued by the sudden change in 5 year expectations just in last 3 days. are inflation fears back in vogue?
 
Well I am starting to consider them more and more…but my fashion sense and financial sense are rarely “in vogue”. Bankin’: yes I believe it is an inflationary item as well. I think I recall the breakeven inflation level for TIPs being advantageous at 57bps the other day…YoY it is 3.7% (granted some of that is dropping off).
 
> i for one am intrigued by the sudden change in 5 year expectations just in last 3 days. are inflation fears back in vogue?
could it be the onset of the hyperinflation scenario I’ve been trumpeting?
 
Also remember TIPS have a floor at $100 - they never lose nominal money. So if you have an on the run TIPS issue, there is actually quite a valuable option in there so you can’t interpret it as a pure inflation expectation.
This isn’t true of Index linked gilts though. Just thought I’d throw that in there…
 
the inflation factor on the TIPS 3% 7/15/12 is 1.214. So 500 face has an adj face of 607.
“The index ratio for any valuation date is the ratio of the Reference CPI-U applicable to the original issue date of the security.”
So if CPI deflates, the inflation factor decreases from 1.214, and then the 607 spent declines to 5X0 with a floor of 500- the initial face amount… I think.
I am not certain but if CPI-U deflates by 20% between now and 2012, (well first of all if that occurs we will probably be out of work or at least we will have much bigger problems to deal with), but still, if that took place it would be possible to lose 107k on this trade as the inflation factor deflates to 1.0. Right?
 
It also depends on what price you paid for the TIP. In your example, if you buy that TIP with a factor of 1.214 and say you paid 82.37 (82.37 x 1.214 = 100) for the TIP, then it’s essentially impossible to lose money. However, if you buy it at say 90 (90 x 1.214 = 109.26), then there’s a possibility in a deflationary period that you could lose some of your initial principal (minus the interest you received)…
 
soxboys… that’s exactly the reason I won’t touch the TIP ishare.
I bought a ten year tip that traded at a 1.7% ytm if there was ZERO(or less) ongoing inflation. All the inflation that is coming will be gravy.
 
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