Investors are getting paid what seems like a lot to buy inflation protection for decades ahead. But longer-term bonds also come with longer-term risks.
Treasury inflation-protected securities, or TIPS, are government-issued bonds that in the simplest terms pay a yield on top of the rate of inflation. In effect, they offer the protection that an investor's money can at least keep up with inflation, plus some extra.
Some investors might say, "You had me at inflation protection." What's more, the market isn't setting some enormous inflation hurdle. The yield on a 30-year nominal, or "regular," Treasury bond is over 5.2%. The 30-year TIPS is paying what is known as a real yield -- or the rate on top of inflation -- of around 3%.
That difference is known as the break-even rate. A common way to look at these bonds is to say that as long as the rate of inflation is above that difference, or roughly 2.2%, TIPS will have outperformed an equivalent-length regular bond at maturity.
That hurdle might seem like a low bar to investors who are very worried about oil, fiscal deficits, artificial intelligence, or lots of other price pressures. But the further out you try to predict the future, the greater the uncertainties become. That makes shorter-term TIPS a better option for most.
First, you have to consider the kind of inflation that is being measured. TIPS track the consumer-price index, not seasonally adjusted, for urban consumers. This has the benefit of including food and energy costs -- things that economists often exclude as they seek to measure "core" inflation but which are obviously quite relevant expenses for most humans.
The most recent reading of this headline measure was 3.4% year-over-year in July. The core inflation rate was 2.5%.
But CPI is also just one measure of inflation. The cost of key expenses that people might be saving up for in future years, like college tuition or eldercare, have at times risen far faster than the index. As a result, you might not ultimately feel like TIPS have fully protected your purchasing power after decades of waiting.
Federal Reserve Chairman Kevin Warsh in July said during a Senate hearing that measures like the CPI and producer-price index are "imperfect measures of the state of underlying inflation."
How the CPI is calculated also isn't fixed forever. Historically, it has been a subject of frequent debate and technical adjustments.
But making bets based on ideas of future measures of future inflation is, needless to say, pretty difficult. Instead, investors in long-term TIPS should be thinking beyond inflation forecasts and about the risk that is shared by all long bonds: That future interest rates will be higher.
For TIPS, that means focusing on the real yield that is on top of the inflation rate. Even if everyone is expecting hotter inflation, if the level of interest rates is also higher than expected, TIPS might still lose value.
Currently, the real yield offered on 30-year TIPS at the market price is higher than at any time in the last several years, getting to over 3%. That high yield is also coming at a time when stock index valuations are still elevated, making the relative attraction of that long-term yield more competitive with equities than is typical.
But a lot of forces can drive real yields higher. Depending on whom you ask, it could be faster economic growth, or changes in the supply of, or global demand for, Treasury bonds. There is also AI's voracious demand for financing, which could drive up borrowing costs, as well as its impact on productivity.
Any of these concerns could cause investors to price in more risk of higher long-term rates, causing the prices of TIPS and other long-term bonds to fall. That is a risk if you aren't committed to holding the bonds to maturity.
So a lot of investors might want to focus on shorter-term inflation protection. Real yields on five- and 10-year TIPS aren't at the same level as 30-year TIPS, but they are still near their highest levels in years. Five-year TIPS currently carry real yields of over 2.1%. The break-even rate is 2.2%.
Some investors also choose to "ladder" their TIPS investments, with a series of successive maturities to spread their bets over shorter-term and longer-term instruments. There are also ETFs that enable investors to buy shorter-term TIPS.
At current prices, TIPS give investors good inflation protection and decent yield, at least for the next couple of years. Longer term than that, nothing offers perfect certainty.