Retirees and those looking for a secure income received two very good pieces of news this week, although you may have only heard of one.
Inflation in July came in below fears (although there is now some debate over what the ‘real’ inflation rate is – more below).
Meanwhile, your ability to earn a guaranteed rate of return on risk-free investments, regardless of what happens with inflation, increased.
So-called TIPS, inflation-protected Treasuries, have fallen slightly in price this week. And as a result, the interest rates available to new buyers increased. (Bonds work like see-saws: when the price goes down, the interest rate “yield” goes up.)
A 5-year TIPS bond is now guaranteed to beat inflation by 0.3% per year through 2027, regardless of what inflation is, and a 30-year TIPS bond is guaranteed to beat inflation by nearly a percentage point complete for each course. This equates to a 35% increase in purchasing power between now and 2052.
What will happen to inflation during this time? I have no idea. Nor anyone else. Some extremely smart and experienced financial assistants, including fund managers David Einhorn Capital green light i Jonathan Ruffer in London—think that inflation will increase, and continue to increase. Einhorn recently suggested that the recent drop in inflation, to borrow last year’s word, is likely to be “transient.”
Could they be right? President Biden boasted this week that inflation was down to 0%, but at the same time noted on Twitter that the labor market is booming and that workers have bargaining power they haven’t had in decades, which means wages are likely to expand. up
The increase in wages would not be inflationary if it were accompanied by increased productivity, but unfortunately the The latest data shows that labor productivity has plummeted this year.
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So people who say inflation hasn’t gone away may not be crazy.
On the other hand, you have to wonder about all these millions of people who, perhaps unwittingly, are betting on another side.
This includes anyone who owns regular or nominal Treasuries. If you are a retiree or a low-risk investor and have the standard type of balanced or lower-risk portfolio, it will probably include you.
The standard 5-year Treasury note (not hedged against inflation) yields around 3%. The 10-year yields less, around 2.9%. 30 year olds are only slightly above 3%. These returns only make sense if you believe that inflation has collapsed and will continue to collapse.
I’ve written here before about so-called “breakeven points,” a technical measure of the bond market that effectively anticipates future inflation. Right now, the 5-year balance is 2.7% and the 10-year is 2.5%. This means that anyone who owns a 5-year Treasury bond, rather than a 5-year TIPS bond, is unwittingly betting that inflation over the next 5 years will average less than 2.7% per year. Anyone who owns a 10-year Treasury bond, rather than a 10-year TIPS bond, is betting that inflation will average less than 2.5% through 2032.
That’s quite a gamble.
It’s a mystery to me why these traditional or old Treasuries are still considered “risk-free” assets. They only pay nominal interest rates. Buy a bond paying 3% per year for 10 years and see how risk-free it is if inflation reaches 10% per year.
Frankly, it’s hard to see much advantage in buying traditional bonds over TIPS. Even if inflation is low, how high will it be? And do you really want to gamble with your retirement account?
Meanwhile, in case you missed it, the last few days have seen one of those political debates about the “real” rate of inflation. The president, supported by his official spokesman, has argued that it is really 0% because prices did not move between June and July. Its critics have argued that the real rate is 8.5%, because that is the change in prices in July from a year earlier.
I am not insensitive to the case of looking at the latest monthly price increase. After all, it’s the latest data. But extrapolating that to “inflation is 0%” is the kind of PR stretch that turns a good data point into a benchmark.
In the meantime, I have a suggestion.
To all those people who are now cheering that the true inflation rate is now 0%, bet on it. Go out and buy zero-coupon 30-year bonds, paying 3.1% per year from now until 2022 and 2052. If you’re right, you’ll make out like bandits.
Good luck.
Meanwhile, if you live in the real world and pay real prices in real stores and don’t really want to bet your life savings on future economic indicators, TIPS bonds over regular Treasurys seem like an easy option to me.
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