What Is the TIPS Spread?
The TIPS spread is the difference in yield between a Treasury bond and the yield of treasury inflation-protected securities (TIPS) with similar duration.
This provides valuable insights into market expectations for inflation. A widening spread indicates increasing inflation expectations, while a narrowing spread suggests decreasing inflation expectations.
The TIPS Spread also tells investors the breakeven inflation rate that is priced into Treasury Inflation-Protected Security Prices.
If future inflation is lower than the current TIPS spread, investors would benefit in purchasing Treasury Bonds instead of TIPS.
If future inflation is above the TIPS Spread, an investor who purchased TIPS would have seen a higher return than an investor who purchased a standard Treasury Bond.
How Do You Calculate the TIPS Spread?
For example, let’s calculate the 10-Year TIPS Spread:
First, find the yield of the current 10-Year Treasury Bond. Let’s say it is 4.2%
Then, find the interest rate of a current 10-Year TIPS Bond. Let’s say it is 1.375%
4.2% – 1.375% = 2.825%
The current TIPS spread in this scenario is 2.825%.
Or, said another way, the 10-Year inflation breakeven rate is 2.825%
This spread implies that the market is pricing in average inflation of 2.825% per year for the next 10-years.
Data to Calculate The TIPS Spread Today
To determine the TIPS spread today, you need 2 data points:
1) Current bond yields for a Treasury Bond
2) The coupon yield on TIPS
To find the yield of a current Treasury Bond, I like using the Bonds and Rates page from The Wall Street Journal.
To fund the coupon rate on TIPS, I like to look at the coupon yield for the most recent TIPS auction at Treasury Direct.
What It Means for Individual Investors
The TIPS spread, or Treasury Inflation-Protected Securities spread, can be a valuable tool for individual investors to gauge market inflation expectations and quantify inflation risks of their bond investments.
When the TIPS spread is large, it tells you that the market is forecasting high rates of inflation.
This may be a time that a contrarian investor would purchase traditional Treasury Bonds, since the market’s forecasts of inflation are at relative highs. When TIPS Spreads are wide, TIPS become less attractive since investors are receiving relatively high yields for traditional bonds.
Likewise, with the TIPS spread is narrow, it tells you that the market is forecasting very low future inflation.
This is a time when purchasing traditional Treasury Bonds have significant inflation risks, because investors are getting very little excess return compared to a TIP. When spreads are narrow, TIPS become more attractive since investors pay less for inflation protection.
Historical Data on TIPS Spread
The Federal Reserve Bank of St. Louis has the best collection of data for historical TIPS Spreads.
From 2003 through 2023, spreads between the 10-Year TIPS Yield and the 10-Year Treasury yield have ranged from very close to 0% to 3%:
Make Investment Decisions
Notice 2 periods in the chart above where the inflation breakeven rate was low; December 2008 and May 2020. How would the performance of an investor in TIPS compare to that of one who used Treasury Bonds at that time?
For the December 2008 time frame:
For the May 2020 time frame:
Notice that in both of these periods, when the TIPS Spread was narrow, Treasury inflation protected securities outperformed regular Treasuries bonds!
What to Know
When you compare regular Treasury bonds with TIPS, it can help you understand what the market expects for future inflation.
For regular Treasury bonds, the interest they pay needs to cover two things: the real interest rate and compensation for expected inflation.
TIPS, on the other hand, adjust their principal value based on inflation, so their yield only reflects the real interest rate.
So, the difference between the yields of regular Treasury bonds and TIPS gives you an idea of the expected inflation compensation over a certain period.