TIPS Spread

A “TIPS spread” is used to predict investors’ expectations about changes to the inflation rate. If the spread is narrow, investors expect the inflation rate to stay where it is. If it’s wide, they expect the inflation rate to go up.

So where does this spread come from? Well, we take a look at the yield of a U.S. Treasury security with a certain maturity date. Then we look at the yield of the TIPS—that’s Treasury inflation protection securities—with the same maturity date, and we compare the two. The bigger the difference—in other words, the wider the spread between the two yields—the higher inflation is expected to jump.

Is the TIPS spread a 100% reliable indicator of inflation rate changes? Eh, not always. It’s a good indicator of whether or not there’s going to be an inflation rate change, but it tends to underestimate what that change will be more often than not. The Fed tries to keep inflation somewhere in the neighborhood of 2%, but it can’t always account for or predict everything that’s going to happen in the markets. And so, just as with every other indicator out there in the world, the TIPS spread is a tool that should be used in conjunction with other financial indicators and analyses if we’re going to use it to guide our investment decisions.