The 5 year TIPS hit a record low of -.54% on July 12 and 13 (http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield).
For individuals investing in fixed income in taxable accounts here is what I’m looking at when I face a decision to purchase a high quality bond right now. Let’s assume inflation is estimated by the breakeven inflation rate which in the last few days has been running right around 2.0%.
If I invest in a 5yr TIPs, and I’m paying AMT my after tax return will be roughly (2% – 0.54%) * (1-.28) =1.05% or a -0.95% after tax return real return. Note that I neglect state income tax which is not levied on Federal bonds.
Another high quality alternative is a triple tax exempt AAA rated muni bond. These are available at roughly 1.3% yield to maturity resulting in a -0.7% after tax return real return. Better, but still dismal for fixed income investors.
While I’m watching these yield curves hit bottom I wasn’t surprised to see the Treasury is auctioning new TIPS this week. My only surprise was they are offering 10 year TIPSs that have a positive real return. As a tax payer I was hoping they would sell 5 yr TIPS at the absolute best historic price ever.
Is the 25 basis point advantage of the muni enough to overcome the risk that inflation is greater than 2.0% ? To help answer this I computed that if inflation was 2.35% over the five year period the return on the muni and the TIPS would be equivalent. Would I pay 25 bp to insure against inflation exceeding 2.35% …. probably a bargin.