On April 13, 2020, we published a Blog explaining why it was a poor time to own Treasury Inflation-Protected Bonds or TIPs. A mere 14 months later, our position has reversed, but not because we are wishy-washy or undecided. The national situation has changed dramatically, so investment strategies need to be revised and updated to reflect our current financial environment.
Since 1997, TIPs have presented investors with bond interest, plus an extra “kicker” in the form of an inflationary adjustment. The inflation adjustment is made by raising the principal value of the bond by the reported rate of inflation for the prior year.
Early in 2020 the world was presented with a COVID-19 pandemic, and the resultant economic shutdown drastically reduced overall consumer demand for goods and services. Reported inflation turned negative. While TIP values are not revised down during deflationary periods, they are not revised up until all accumulated deflation has been offset by subsequent inflationary increases.
Also in early 2020, interest rates were already close to zero and showed few signs of being increased any time soon. With U.S. inflation reports being negative and interest rates being close to zero, we could not justify buying TIPs in early 2020. However, nothing stays the same for long.
Fast forward to June 2021, and conditions are vastly different. Consumer demand has outstripped supplies of many goods and services, leading to rising prices. Even government wizards, who manage to vastly underreport inflation, are admitting that the Consumer Price Index (CPI) is now rising rapidly. The period of declining CPI is over and forgotten (for now, anyway), and the cost of living is higher than ever.
Adding to the pro-TIP argument is the fact that several members of the FED have stated that ZIRP (Zero Interest Rate Policy) cannot last much longer. Rates will have to rise in an attempt to dampen inflation. In the new environment, TIPs are looking more sensible, and investors are paying attention.
While TIPs can be purchased in a number of forms, we like the iShares TIP Exchange-Traded Fund (ETF). Fourteen months ago, the market price of TIP was about $121.85. oN June 4, 2021, the closing price was $127.48, representing an increase of about 4.7%. In addition, TIP pays a monthly dividend whenever the combination of inflation adjustment plus underlying bond interest is positive.
Since June 1, 2020, TIP has paid a monthly dividend only half the time. This month, TIP is paying over $0.68/share, the largest monthly payout since June of 2008. This reflects the recent rising inflationary environment. We anticipate more inflation and more TIP dividends for the balance of 2021. This could be helpful for investors who are seeking diversification and income.
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