Why a 30-Year TIPS Can Move So Much When Real Yields Change
At a 3.22% real yield, a move back to 1.50% could lift the modeled price of a 30-year TIPS strip by 65.6%.
By Eli Breece ·
The 30-year TIPS real yield stood at 3.22% on September 25, the latest official Treasury reading available as I write this.
This represents a yield above inflation.
Bu there's the question we need to address today: What would happen to the real value of a payment due in 30 years if that yield fell to 1.50%?
At a 3.22% real yield, a hypothetical zero-coupon TIPS payment of $100 in today’s purchasing power has a modeled value of $38.64.
At 1.50%, the same payment would be worth $63.98. That is a 65.6% increase in price from a 1.72 percentage point decline in yield.
There is nothing unusual in the arithmetic. A payment made three decades from now has to be discounted for three decades. Lower the discount rate, and the present value rises.
The effect is especially strong for a zero-coupon security because the investor receives no cash along the way. All of its value is tied to the final payment.
The $38.64 and $63.98 figures are calculated values, not quoted prices for a particular TIPS strip. The comparison assumes an immediate change in yields and 30 years remaining in both scenarios.
An ordinary TIPS pays interest every six months, so its price generally would move less than the zero-coupon example shown in the chart. Treasury securities can be separated into STRIPS, which make a single payment at maturity.
The appeal of TIPS is pretty straightforward overall: Their principal adjusts with inflation, and their interest payments are calculated on that adjusted principal. At maturity, Treasury pays the greater of the inflation-adjusted principal and the original principal.
For someone investing toward a known expense many years from now, a high real yield can be valuable even if bond prices never rally. It offers a way to set aside purchasing power rather than betting on a particular path for inflation. A long TIPS strip takes that idea to an extreme: one distant inflation-linked payment, with no interim coupons to spend or reinvest.
The questions we need to ask:
1. Is whether today’s real yield is attractive for money that can remain invested for decades?
2. Are we comfortable with the price volatility that comes with a payment so far in the future?
The chart makes a strong case for how much upside a decline in real yields could create.