Buying a Negative Yield

As investors' worries about inflation grow, they are increasingly willing to pay a premium to protect themselves against future rises in consumer prices. According to Bloomberg, the U.S. sold $13 billion in 10-year Treasury Inflation Protected Securities at a record low negative yield of -0.089%. The market is factoring in inflation over the next 10 years even if the Federal Reserve Board and others are not planning on inflationary pressures any time soon.

Investors have been questioning themselves about the wisdom of buying a 10-year Treasury that is paying 2.25% with the Consumer Price Index (CPI) cruising at 3.3% and likely to go higher. That disparity between the rate and the CPI guarantees a loss of purchasing power. As a result, some investors have turned to Treasury Inflation Protected Security (TIPS).

The principal on TIPS increases with inflation and decreases with deflation, as measured by the CPI. The greater of the original or adjusted principal is paid at maturity. TIPS pay interest twice a year at a fixed rate. The rate is applied to the adjusted principal so the amount of interest received is also tied to inflation. The stated interest rate associated with the record-low negative yield is 0.125%, so you do not buy TIPS to make a lot of money, but to preserve principal.

Our outlook for oil calls for more inflationary pressure over the next year. Energy, food, medical, and transportation are all contributing to the rise in the CPI. Businesses must respond to these inflationary pressures even if the Federal Reserve Board does not. Here is ITR's advice: Lock in costs; plan to raise prices; expect interest rates to remain low for too long; select price indices that favor your negotiations with your clients; and find indices that will minimize your exposure to your vendors.