TIPS (Treasury Inflation-Protected Securities)
Treasury Inflation-Protected Securities (TIPS) are U.S. government bonds whose principal value adjusts with the Consumer Price Index (CPI), shielding investors from the erosion of purchasing power caused by inflation. They are issued and backed by the U.S. Department of the Treasury.
TIPS were introduced by the U.S. Treasury in 1997 as a direct-purchase inflation hedge available to all investors. Unlike nominal Treasury bonds, where the face value remains fixed at $1,000 until maturity, TIPS adjust their principal daily based on changes in the non-seasonally adjusted CPI for All Urban Consumers (CPI-U). When inflation rises, the principal increases; during deflationary periods, the principal decreases, though at maturity the Treasury guarantees repayment of at least the original face value.
The coupon rate on TIPS is set at a fixed percentage, but because it is applied to the inflation-adjusted principal, the actual dollar interest payment moves with inflation. For example, a TIPS bond with a 1% coupon and a principal that has grown to $1,050 due to cumulative inflation will pay $10.50 in interest rather than $10.00. This dual adjustment — principal and interest — makes TIPS a more comprehensive inflation hedge than nominal bonds held alongside a separate inflation-indexed instrument.
TIPS are issued with maturities of 5, 10, and 30 years and are auctioned through the Treasury's TreasuryDirect system as well as through primary dealers. Secondary-market liquidity is substantial, and TIPS are held widely by pension funds, insurance companies, foreign central banks, and individual investors. The TIPS market has grown to trillions of dollars in outstanding principal, making it one of the largest inflation-linked bond markets globally.
The breakeven inflation rate, calculated by subtracting the real TIPS yield from the nominal yield of a comparable Treasury bond, is closely watched by Federal Reserve policymakers and market participants as a forward-looking measure of inflation expectations. A widening breakeven suggests markets expect higher future inflation, while a narrowing breakeven signals the opposite. This metric is published by the Federal Reserve Bank of St. Louis and used in academic and policy research.
Investors should be aware that TIPS generate taxable phantom income: the principal adjustments are treated as interest income for federal tax purposes in the year they accrue, even though the investor does not receive the cash until maturity or sale. This characteristic makes TIPS held in taxable accounts less tax-efficient than TIPS held inside tax-advantaged retirement accounts.