What are TIPS?

Treasury Inflation-Protected Securities (TIPS) are US government bonds whose principal value adjusts with the Consumer Price Index (CPI). If inflation is 3% over a year, the principal of a TIPS bond increases by 3%, and subsequent coupon payments are calculated on this higher principal. At maturity, the investor receives the inflation-adjusted principal or the original par value, whichever is greater, providing built-in deflation protection.

TIPS are issued in 5-year, 10-year, and 30-year maturities. Their yield, known as the "real yield," represents the guaranteed return above inflation. When the 10-year TIPS yields 2%, investors are locking in a 2% annual return on top of whatever inflation turns out to be. This makes TIPS fundamentally different from nominal Treasuries, where the return is fixed in nominal terms and inflation erodes purchasing power.

The difference between a nominal Treasury yield and a TIPS yield at the same maturity is the "breakeven inflation rate," representing the market's implied inflation expectation. If the 10-year nominal yield is 4.5% and the 10-year TIPS yield is 2%, the 10-year breakeven is 2.5%, meaning the market expects average inflation of approximately 2.5% over the next decade. The Fed monitors breakevens closely as a gauge of inflation expectations anchoring.

For investors, TIPS serve dual functions. They provide direct inflation hedging for portfolios, performing well during inflationary periods when nominal bonds lose value. They also offer information content through real yields and breakevens. A rising real yield tightens financial conditions for long-duration assets like growth stocks and gold, because it increases the opportunity cost of holding non-yielding assets. The 10-year real yield has become one of the most important single variables for cross-asset allocation, rivaling the VIX as a macro regime signal.