Interest Rate Watch: Regular Treasury vs. TIPS vs. Breakeven Inflation Rates

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There continues to be a lot of interest rate movement in savings accounts, CDs, and other cash equivalents. I find the most interesting corner right now to be the rise of real yields on TIPS (Treasury Inflation-Protected Securities) and their relationship with traditional Treasury bonds. Roughly 1/3rd of my bond allocation is to TIPS.

TIPS can be a bit complicated, but basically they are priced based on their real yield. As of 9/26/22, the closing real yield on a 5-year TIPS was 1.82%. This is the highest real yield since the 2008 Financial Crisis, and we’ve had negative yields for much of the last decade. (Source: FRED)

(As an inflation-linked bond, a TIPS with a 1.82% real yield means that if the CPI-U inflation is 3%, then your total yield will be 4.82%. “Real” means after adjusting for inflation. TIPS thus “protect” you from unexpectedly high inflation. If inflation ends up being 10%, you’ll get 11.82%. However, if inflation is very low, your yield will also be affected the other way.)

As of 9/26/22, the closing nominal yield on a regular 5-year Treasury was 4.15%. That means the 5-year “breakeven” inflation rate was 2.33%. If you bought equal amounts of both the 5-year Treasury and 5-year TIPS today, the winner after 5 years will depend on whether the future inflation rate ends up being higher or lower than 2.33% over the next 5 years. This creates a market-based estimate of future inflation rates. Here’s the historical 5-year breakeven inflation rate for the last 10 years:

Looking back, TIPS underperformed regular Treasuries for 11 out of the 16 10-year periods ending 2013-2021, as inflation was usually lower than the breakeven rate. Image credit to TIPSWatch.

At this moment, there are 5-year brokered CDs at 4.20% (non-callable) and the 5-year Treasury at 4.15%. Purely my opinion, but I would consider the 5-year TIPS over both of those options as I like the combination of a decent 1.83% real rate and a modest 2.33% breakeven rate. I would take the risk of underperforming regular Treasuries by a little bit in exchange for the insurance against high inflation. This is why I usually hold mix of TIPs and Treasuries for the bond allocation of my portfolio.

Note that current Savings I Bonds only have a 0% real rate and we’ll see how much they raise it in November (my bet: not nearly as high as the 5-year TIPS). So TIPS would even beat savings bonds right now in my book (as a long-term bond holding). However, the situation is changing daily and I don’t know what the rates will look like when I actually have significant cash available to re-invest.

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  1. newsflash: 5-year TIPS need to be locked up for 5 years.

    This would not bother retirees, as they ladder and hedge, but is a non-started for early savers who don’t need long-term bonds.

    • Sorry if I wasn’t clear. I was comparing 5-year term products as noted in the beginning of that paragraph. 5-year CD, 5-year Treasury, 5-year TIPS. Each of these will have some sort of potential penalty if you withdraw early. You can always sell Treasuries and TIPS on the secondary market at any time, but the price will depend on prevailing interest rates. Brokered CDs are also pretty hard to get rid before their term ends. You can’t sell savings bonds in their first 12 months at all.

      It all depends on what you needs are, here I am not talking about 100% liquid cash.

  2. I expect the yearly return on Ibonds after the 3 month interest penalty will be ~6%. Are you saying the TIPS rate will beat that? That would mean inflation will be much higher than the current break even rate. I realize Ibonds and TIPS are different products used for different investment strategies but you post is focused on rate of return.

    • Sorry if I wasn’t clear. I’m comparing 5-year term products. 5-year CD, 5-year Treasury, 5-year TIPS. Mainly I’m pointing out for long-term holders that savings bonds have a 0% real yield right now.

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