TIPS Outperform Treasurys in 2018 First Quarter

  • TIPS on average declined 1.1% on the 2018 first quarter, less than the 1.6% decline in comparable maturity straight Treasurys.
  • The average breakeven spread widened to 222 basis points from 184 basis points at the end of the 2017 fourth quarter.
  • Most of the widening was due to a sharp drop in short-maturity TIPS yields, as investors sought a safe haven in a rising interest rate environment.
  • With interest rates backing off a bit, longer-term TIP offer better relative value, but they will still be vulnerable to declines, if interest rates continue to rise.

In a quarter characterized by rising interest rates, TIPS outperformed comparable maturity straight Treasurys, but still produced a negative return. On average, TIPS fell 1.1%, less than the 1.6% decline in comparable maturity straight Treasurys. During the quarter, the average yield on TIPS rose by two basis points (bp) to 0.36%, while the average yield on straight Treasurys increased by 40 bp to 2.58%. As a result, the average spread between straight Treasury and TIPS yields increased by 38 bp from 184 bp to 222 bp.

Given the sharp increase in the yield spread, I was somewhat surprised to see the relatively small performance differential between TIPS and straight Treasurys. Intuitively, TIPS should have performed much better. That anomaly caused me to double check my yield and return performance calculations.

For the record, my calculations exclude the newly issued TIPS, primarily because their returns over a partial quarter were affected significantly by where they were priced at issuance. Including them, I believe, would have distorted the average performance for the TIPS universe.

The Treasury-TIPS yield (or breakeven) spread widened primarily because the average yield on short maturity TIPS, declined by 31 bp to -0.24%. Average yields in all other maturity categories for both TIPS and straight Treasurys increased during the quarter (by about 15-25 bp for TIPS and 25-35 bp for straight Treasurys).