I want to make sure I fully understand to place the right trade. There are 2 ways to trade this
1) just buy the TIPS, or
2) buy the TIPS and simultaneously sell an equivalent amount of the long bond. This reduces the trade cost? and more closely tracks the inflation? any increased risk with selling the bonds as well in the case of a correction?
I want to make sure I fully understand to place the right trade. There are 2 ways to trade this
1) just buy the TIPS, or
2) buy the TIPS and simultaneously sell an equivalent amount of the long bond. This reduces the trade cost? and more closely tracks the inflation? any increased risk with selling the bonds as well in the case of a correction?
If you just buy the TIPs, you are subjected to potential increases in nominal rates. So, let's say you buy the 30-year TIP at -1.12% yield. That means you will get inflation minus 1.12% over the life of the bond. Let's say inflation averages 4%. That means you will get 2.88% return.
But what if nominal rates go to 5%? Your TIP will go down, but it won't go down as much as the nominal bond.
That's why if you short the nominal bond, you are taking out the interest rate component, and merely exposing yourself to inflation.
You will only be subjected to the changes in market expectations about inflation, as opposed to also including the changes in interest rates.
thanks Kevin - in this case why not going long short end tips? is it because short end tips yields are way too negative so the likelyhood to have a negative return (after inflation) is almost certain?
Flower Smuggler - one of the smartest big macro old investors I know recently told me that this what he has been telling people to buy - 2 year TIPS. And I have no trouble with owning them. The reason I don't is that I am so bullish on inflation, I want exposure for longer-duration inflation.
But, if you were only in the "reflation" camp as opposed to the "inflation" camp, then this trade would be ideal.
However, you are also correct in that 2-year TIPS are yielding -2.17%, so really, how much are you going to make? Maybe inflation ends up being 4%, so you make a shade under 2%. That's good, but I would rather benefit from the wholesale change in expectations about future inflation.
So, I am actually long 30-year TIPS. I hedge them with ultra bond futures, and then trade my steepeners seperately.
Hi Kevin
I want to make sure I fully understand to place the right trade. There are 2 ways to trade this
1) just buy the TIPS, or
2) buy the TIPS and simultaneously sell an equivalent amount of the long bond. This reduces the trade cost? and more closely tracks the inflation? any increased risk with selling the bonds as well in the case of a correction?
Thanks in advance
Paul
Hi Paul,
If you just buy the TIPs, you are subjected to potential increases in nominal rates. So, let's say you buy the 30-year TIP at -1.12% yield. That means you will get inflation minus 1.12% over the life of the bond. Let's say inflation averages 4%. That means you will get 2.88% return.
But what if nominal rates go to 5%? Your TIP will go down, but it won't go down as much as the nominal bond.
That's why if you short the nominal bond, you are taking out the interest rate component, and merely exposing yourself to inflation.
You will only be subjected to the changes in market expectations about inflation, as opposed to also including the changes in interest rates.
Hope that helps.
Kev
Don't forget, I think bonds will be an anchor around your portfolio's neck in the coming years/decades.
Thankyou
thanks Kevin - in this case why not going long short end tips? is it because short end tips yields are way too negative so the likelyhood to have a negative return (after inflation) is almost certain?
Flower Smuggler - one of the smartest big macro old investors I know recently told me that this what he has been telling people to buy - 2 year TIPS. And I have no trouble with owning them. The reason I don't is that I am so bullish on inflation, I want exposure for longer-duration inflation.
But, if you were only in the "reflation" camp as opposed to the "inflation" camp, then this trade would be ideal.
However, you are also correct in that 2-year TIPS are yielding -2.17%, so really, how much are you going to make? Maybe inflation ends up being 4%, so you make a shade under 2%. That's good, but I would rather benefit from the wholesale change in expectations about future inflation.
So, I am actually long 30-year TIPS. I hedge them with ultra bond futures, and then trade my steepeners seperately.
Hope this helps!
Kev