Retirees and those looking for a secure income received two very good news this week, although you may have only heard of one.
of July inflation was below fears (although there is now a debate about what the “real” rate of inflation is, more on that below).
Meanwhile, your ability to earn a guaranteed rate of return on risk-free investments, regardless of what happens with inflation, actually increased.
The so-called TIPS bonds, Treasury bonds protected against inflation, fell slightly in price this week. And as a result, the interest rates available to new buyers increased. (Bonds work like seesaws: when the price falls, the “yield” interest rate rises.)
A 5-year TIPS bond is now guaranteed to outperform inflation by 0.3% per year between now and 2027, no matter what inflation turns out to be, and a 30-year TIPS bond is guaranteed to outperform inflation by nearly one point full percent per year. year. That equates to a 35% increase in purchasing power between now and 2052.
What will happen to inflation during that time? I have no idea. Nor anyone else. Some extremely smart and experienced financial wizards, including fund managers David Einhorn at capital green light Y Jonathan Ruffer in London—thinks inflation is going to go up, and it keeps going up. Einhorn recently suggested that the recent drop in inflation, to borrow the word from last year, is likely to prove “transient”.
Could they be right? President Biden boasted this week that inflation was now down to 0%, but at the same time noted on Twitter that the job market is booming and workers have bargaining power they haven’t had in decades, which means that wages are likely to fall. up.
The increase in wages would not be inflationary if it were accompanied by an increase in productivity, but unfortunately the Latest data shows labor productivity has plummeted this year.
Learn how to shake up your financial rut at Festival of the best new ideas on the money on September 21 and 22 in New York. Join Carrie Schwab, President of the Charles Schwab Foundation.
So the people who say that inflation has not disappeared may not be crazy.
On the other hand, you have to wonder about all those millions of people who, perhaps without knowing it, are betting on the opposite.
That includes anyone who owns regular or nominal Treasury bonds. If you’re a retiree or low-risk investor, and you have the standard type of balanced or lower-risk portfolio, that probably includes you.
The standard (non-inflation protected) 5-year Treasury bond yields about 3%. The 10-year-old yields less, around 2.9%. Year 30 is only slightly above 3%. Those returns only make sense if you think inflation has collapsed and will continue to collapse.
I’ve written here before about so-called “break-even points,” a technical measure in the bond market that effectively anticipates future inflation. Right now, the 5-year breakeven is about 2.7% and the 10-year breakeven is about 2.5%. What this means is that anyone who owns a regular 5-year Treasury bond, rather than a 5-year TIPS bond, is unknowingly betting that inflation over the next 5 years will average less than 2.7% per year. Anyone who owns a regular 10-year Treasury bond, rather than the 10-year TIPS bond, is betting that inflation will average less than 2.5% between now and 2032.
That’s a big bet.
It’s a mystery to me why these old-fashioned or traditional Treasury bonds are still considered “risk-free” assets. They only pay nominal interest rates. Buy a bond that pays 3% per year for 10 years and see how risk-free it is if inflation hits 10% per year.
Frankly, it’s hard to see much of an advantage in buying traditional bonds over TIPS. Even if inflation is low, how low will it be? And do you really want to be gambling with your retirement account?
Meanwhile, in case you missed it, there has been one of those political debates over the “real” rate of inflation in recent days. The president, backed by his official spokesperson, argued that it is actually 0% because prices did not move between June and July. Critics of him have argued that the real rate is 8.5%, because that is the change in prices in July from a year earlier.
I am not indifferent to the case of looking at the most recent monthly price increase. They are, after all, the most recent data. But extrapolating from that to “inflation is 0%” is the kind of PR stretch that turns a good data point into a joke.
Meanwhile, I have a suggestion.
To all those people who are now celebrating that the true rate of inflation is now 0%, go bet on it. Go out and buy 30-year zero coupon bonds, locking in 3.1% interest per year between now and 2022 and 2052. If you’re right, you’ll go out like a crook.
In the meantime, if you live in the real world and pay real prices in real stores, and don’t feel like gambling your life savings on future economic indicators, I find TIPS bonds over regular Treasuries an easy option.