Sunday, July 22, 2012

Long-Term Real Interest Rates Drop Below Zero

Since 2000, the real yields on TIPS have experienced a gradual decline. This is good news for current TIPS owners to the extent that they can enjoy capital gains on the value of their holdings. But it is bad news for those wishing to purchase TIPS now to help finance long-term goals. The bad news is that financing those goals has become a lot more expensive. The following chart from the Treasury Department shows the Long-Term Real Rate Average, which they define as "the unweighted average of bid real yields on all outstanding TIPS with remaining maturities of more than 10 years and is intended as a proxy for long-term real rates." These rates dipped below zero at the start of June and then rose briefly again. But as of July 20, 2012, the average rate has fallen below zero again to its lowest level in history: -0.04%.

As this is a real yield, it can fall below zero. Investors are still locking in returns that will keep pace with inflation, which is not something that can be guaranteed with traditional Treasury instruments. While I'm not in the business of making forecasts, I certainly think it is just as likely that TIPS yields will continue to fall as they will begin to rise. Rising TIPS yields will result in capital losses for current owners, but I, for one, am still staying the course with my current allocation to TIPS mutual funds. 

For those approaching retirement, these low TIPS yields provide a valuable motivation to delay the Social Security claiming decision, and this certain speaks against the idea of claiming Social Security early with the idea in mind of investing the Social Security benefits for yourself. It will be hard to beat the implicit real rate of 2.9% provided to those who delay Social Security.