Amid inflation fears, U.S. will boost issuance of ‘TIPS’

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If higher inflation is on the horizon, bond investors will have more opportunities to hedge that risk: The Treasury says it expects to issue more inflation-protected bonds in the fiscal year beginning Oct. 1.

The government has been selling Treasury Inflation-Protected Securities, or TIPS, for more than a decade, but they’re still a small part of Uncle Sam’s total debt. That makes sense, because inflation hasn’t been much of a concern -- so the appetite for bonds guaranteed to earn returns that keep up with inflation hasn’t been huge.

There were $532 billion of TIPS outstanding at the end of June, accounting for just 8% of the $6.6 trillion of Treasury debt held by the public.

But ‘market participants can expect [TIPS] issuance to gradually increase’ in the new year, the government said Wednesday in its quarterly statement on future borrowing plans.

The timing isn’t a coincidence: The Treasury knows that many potential buyers of U.S. bonds -- including China -- fear that inflation could surge given the massive sums the Treasury and the Federal Reserve have pumped into the financial system since last fall.

Rising inflation would erode the value of fixed-rate bonds. If inflation jumped to an annual rate of 5%, a 10-year Treasury note bought at the current annualized yield of 3.76% would plunge in value.

With TIPS, however, the principal value of the bonds adjusts each year to keep up with any increase in the Consumer Price Index.

Besides boosting the volume of TIPS to be sold, the Treasury said it may consider replacing sales of its 20-year TIPS bond, now the longest-term issue, with a 30-year security. That could help long-term investors such as pension funds better hedge their portfolios for inflation and protect retirees’ benefits.

Marc Chandler, head currency strategist at Brown Bros. Harriman in New York, said the Treasury’s move to ramp up TIPS issuance suggests the Obama administration wants to show that it will be serious about restraining inflation if the economy recovers enough to make that a worry.

By issuing TIPS the Treasury ‘takes on the inflation risk -- transferring it from the investor to the U.S. government,’ he noted.

But many analysts are more concerned with the willingness of the Federal Reserve, which controls the money supply, to begin tightening credit once the economy turns. That will be a politically difficult decision if, as expected, unemployment remains extraordinarily high even as the economy begins to grow again.

-- Tom Petruno