Why a negative yield on TIPS might not necessarily mean inflation

Treasury Inflation-Protected Securities or TIPS, were recently sold with a negative yield. It was widely seen as an expectation of inflation. The problem is TIPS are a one-sided bet, says economics professor Jonathan Wright. 

Here we think that there is no way that QE will not lead to inflation.  Others justify the low yields on TIPS as proof that deflation is here.  Why don't they just interview some of these TIPS buyers and get the real scoop?

Either way, if they do not adjust the principal downward for deflation, wouldn't it roughly be equivalent to a regular treasury.  Those do not get reduced for deflation either. 

What does the recent TIPS auction really say about inflation expectations?
The most recent five-year TIPS auction brought a negative real yield and elicited front page stories in the New York Times and Wall Street Journal about worries of high inflation. The TIPS auction does bring troublesome news for inflation, but it is the opposite of the news reported in the coverage: if anything, the auction suggests anemic inflation, below the Fed’s target range of 1.5% to 2%.
The standard calculation of breakeven rates of inflation based on comparing nominal and real five-year yields suggests that the TIPS bond will give the investor the same return as the nominal bond if inflation over the next five years averages 1.5% per year. That’s low to start with. But in our current situation facing some risk of ongoing deflation, this standard calculation will tend to overstate anticipated inflation. TIPS have the peculiar feature that they are a one-sided bet — while the principal is adjusted upwards for inflation, it is not adjusted downwards for deflation. This makes TIPS more attractive when there is a risk of deflation, pushing their price up and yield down. At present, adjusting for this “insurance against deflation” would lower the implied breakeven rate of inflation to even less than 1.5%.
The interpretation of TIPS yields is particularly important right now due to the acrimonious debate concerning the Fed’s renewed quantitative easing. A careful reading of inflation expectations from the comparison of yields on nominal and index-linked bonds is complicated, but the current configuration of rates indicates that, if anything, investors now expect inflation over the next five years to be too low.


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