On a fixed rate US Treasury, is it possible that preservation of capital could become so important at some point that buyers would accept 0% at any duration? Is that the floor then, as cash in the mattress or safe deposit box would be the alternative at anything less than 0%? For TIPS however, isn't a NEGATIVE % possible? Why would 0% have to be the floor? In a hyper-inflation scenario, would buyers want SOME degree of inflation protection, even if only partial (better than none), and be willing to pay a premium such that a price could be inflation LESS X% (i.e., a discount up to the rate of inflation), rather than inflation PLUS X%? So a TIPS purchased directly even at 0% to 1% today might still be a good long term buy? (Note to self: glad I bought a lot back in Dec. 2008 when a 2.125% rate plus inflation/CPI - which was 2.7% for 2009 - was the going yield!) Am I missing something?
So - is it possible that the difference between a TIPS and the rate on a fixed Treasury of the same duration is no longer just the assumed inflation rate as in normal times - i.e., is there now a disconnect? In other words, buyers are no longer choosing a TIPS over a fixed rate Treasury only because they think inflation will be at least the difference over the duration (as is always assumed) and thus preserve buying power (because now TIPS are guaranteed NOT to keep up with inflation!), but rather, they are buying TIPS as a 'risk avoidance' measure - because the risk of recognizing a capital loss on any fixed rate Treasury in this historical low rate environment is now SO HIGH that ANY protection is preferable to preserve future buying power - even better than stuffing a wad of bills in the mattress or safe deposit box which won't come close to keeping up with even moderate inflation? I think a mindset to 'avoid a loss' is a totally different rationale than just simply comparing fixed vs. variable rates and your personal inflation expectations to determine which gov't guaranteed instrument to buy...
For what it is worth, although I do enjoy looking at the spread between TIPS and nominal Treasuries to come up with some sort of clue what inflation expectations might be I think it is actually fairly useless (for some of the reasons you suggest).
In addition, I would once again argue that...
1. If you are "sure" that serious deflation is coming then US Treasuries would be an excellent investment.
2. If you are "sure" that serious inflation is coming then hard assets would be an excellent investment. TIPS would be inferior to hard assets.
Therefore, the spread between nominal treasuries and TIPS would seem far less important than the spread between nominal treasuries and hard assets (if such a spread could even be calculated).
As you suggest, TIPS are best for those who simply wish to "avoid a loss" in an unknown inflationary/deflationary environment. That's certainly why I am invested in them. I do not wish to make a big bet either way. I'm actually trying to avoid big losses in a very uncertain world.
It would be a mistake for the market to assume that my purchases of TIPS means that I expect serious inflation. All it shows is that I am uncertain. If I truly expected serious inflation and was 100% confident, then I'd be loading up on hard assets big time. Other than things that I know I will personally need and use, I'm not though.
Many people today unfortunately are living day
to day in this current environment, including what their cost of gasoline. Not next month or last month, but
what does a fill up cost me right now because They have to drive to work. Obama doesn't have a bus picking them up.
"This fund has a lot of long bonds in it. I wouldn't worry. They all went in way before 2008."
1. This fund does not have a lot of long bonds in it. 1/3rd of the holdings have a maturity of less than 5 years. 2/3rds of the holdings have a maturity of less than 10 years. The weighted average maturity is just 9.3 years.
2. In my opinion, you should always worry. There are no "sure things", as seen in this fund during late 2008.
3. They all went in way before 2008? What the heck is that supposed to mean and why would it even matter? All that matters is the real yield to maturity of the individual bonds and how much deflation risk they currently have. The older the bonds (and therefore the more inflation has pushed up their value), the higher the deflation risk. There is no advantage to owning older bonds over newer ones.
If you are so sure that serious inflation is on the way, then you could certainly do far better than owning a US dollar denominated treasury bond fund that would pay a negative real yield after taxes (assuming very high inflation rates).
I believe 0% is pretty much the floor if you buy directly in an initial TIPS auction.
"Note About TIPS: Should the accepted auction yield be 0% or less, the security will not have regular semiannual interest payments. The yield will be adjusted for inflation throughout its lifetime, thus posting changes at maturity (or sale). In this case, where the accepted auction yield is 0% or less, the interest rate will automatically be set at 0% (never anything lower) for all buyers."
I would also argue that TIPS will not protect us from serious hyperinflation.
1. Outside of a retirement account, the taxes on the inflationary gains each and every year would be extremely painful.
2. There is a lag. The inflationary adjustment is based on the past. If prices were to double every hour then that lag would ruin us.
If you were to tell me that serious hyperinflation was a sure thing, then I'd be selling the TIPS I own and moving the money to hard assets.
There is no reason to own this over hard assets if you are looking at any kind of inflation. If you have many millions of dollars this might be worth a try, but for those trying to stay above water this is not the place to be. No risk no reward is sadly the age we are in. Only those willing to take investment risk will survive.
I guess 0% in a direct TIPS purchase was NOT the floor:
Maybe I should have followed my train of thought a while back and bought in at the pathetic but slightly positive yields!