Posts Tagged treasury inflation protected securities
Betting Against the Obama Administration’s Economic Policies
Posted by TonyLima in Current issues, Economic policy on March 15, 2013
Two Market Indices
The other day I mentioned to an acquaintance — let’s call him Mr. X — that I had earned about 10 percent per year betting against the Obama administration’s economic policies. I’ll reveal my not-so-secret method shortly. But first I wanted to deal with the reply from Mr. X: if I had put my wealth into the stock market at the beginning of 2012 I would have made a killing.
This is, of course, tantamount to waving a red flag at an angry bull. Today I finally had a few minutes to pull some data together. Before looking at the data, however, I’ll point to an obvious flaw in my acquaintance’s logic: forecasting the past is always easy. Did he put his wealth into the stock market at the beginning of 2012? I doubt it very much.
But I did get curious, so I grabbed Mr. Excel and headed over to the St. Louis Fed’s FRED database to get the S&P 500 and Dow-Jones Industrial indexes. Here are the results. (I have not included dividends because I’m lazy.). Since January 1, 2000 the annual rate of return on the S&P has been 0.45% and the return on the Dow 1.62%.
But, of course, that wasn’t the question. What have the same returns been since January 1, 2012? Considerably better. The S&P is up 14% and the Dow 9.91%.
But we all know the real question: how has the market been doing since January, 2008 when President Obama took office? The S&P has averaged 1.82% per year and the Dow slightly better at 2.13%. Neither of those numbers look real inviting.
As always my methodology is transparent. You can download my Excel workbook by clicking here. But a warning: I’m using the FRED Excel plugin for Excel for the Mac 2011. Those using Excel for Windows are advised to proceed with caution.
So what’s my secret? A TIPS fund. TIPS are Treasury Inflation Protected Securities. They are issued by the U.S. government and are fully indexed for inflation. Once I saw the drastic actions the Fed was taking with its balance sheet and the monetary base, I became very frightened. Heck, I still am. I shifted a big chunk of our retirement accounts to a TIPS fund managed by TIAA-CREF. Since I got scared before most other people, I am enjoying the large capital gains on this fund. Here’s the bad news: it’s probably too late for others to take advantage of this opportunity. Sorry folks.
Use Market Data to Measure Expected Inflation
Posted by TonyLima in Using economic data on October 14, 2011
Introduction
Economists take it for granted that everyone knows the definition of the real interest rate: r = i – p where i is the nominal interest rate and p is the inflation rate. The real interest rate measures the net transfer of purchasing power from borrowers to lenders. Lenders will be repaid i dollars per hundred dollars loaned per year, but the purchasing power of those dollars will decrease by the inflation rate, p. The purpose of this post is to show you how to use market data to measure expected inflation
In principle this is easy. If the market interest rate is 3% and inflation is 1%, the real interest rate is 2%. But if we want to look at future interest rates we need some measure of expected future inflation.
Individuals are, naturally, free to develop their own forecasts of the future inflation rate. This article shows how to use publicly available data to calculate the market’s average expectation of future inflation rates.
TIPS
TIPS stands for Treasury Inflation-Protected Securities. These securities are issued by the U.S. Department of Treasury. Follow that link to learn the details of how it works (links to Treasury site). Since TIPS are adjusted to compensate for inflation, their yield to maturity is the real interest rate. It’s helpful to know that TIPS are issued in maturities of 5, 10, and 30 years. The minimum purchase is a measly $100.
Calculating Expected Inflation
The expected future rate of inflation over 5, 10, and 30 year horizons is the difference between ordinary Treasury securities with those maturities and the yield on TIPS. This is an approximation because coupon payments on ordinary Treasuries are constant, but the coupon (and maturation value) on TIPS securities adjust to the inflation rate. But let’s not allow details to get in the way of a good story.
As of October 14, 2011, here’s what the markets are forecasting for expected inflation:
|
Maturity (years) |
Nominal yield |
TIPS yield |
Expected Inflation |
|
5 |
1.12% |
-0.54% |
1.66% |
|
10 |
2.26% |
0.28% |
1.98% |
|
30 |
3.22% |
1.12% |
2.10% |
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