Introduction

UBS, a Wall Street firm, has recently upgraded 5-year Treasury inflation-protected securities (TIPS) to a “most preferred” status. This move comes as the yield on 5-year TIPS reached its highest level in over 15 years, offering attractive real yields to investors.

Investor Interest in TIPS

In 2021, investors turned to TIPS as a hedge against rising prices and inflation. TIPS’ principal value adjusts alongside changes in the consumer price index, providing a measure of protection. However, in 2022, investors shifted away from TIPS due to their confidence in the Federal Reserve’s ability to curb inflation. Leslie Falconio, head of fixed income strategy in UBS Americas’ chief investment office, explains that while inflation expectations impact TIPS performance, U.S. nominal interest rates also play a significant role.

Rising Real Yields and Market Outlook

Currently, real yields are rising as optimism grows regarding the Fed’s success in avoiding a recession and maintaining higher interest rates. This shift in sentiment is reflected in rising nominal yields as well. Falconio believes this more hawkish Fed stance is already priced into the market, making it an attractive time to invest in TIPS. Despite the expectation of decreasing inflation, the inflation risk premium remains positive.

Benefits of 5-year TIPS

Falconio specifically favors 5-year TIPS due to its yield and sensitivity to short-term factors such as monetary policy changes or oil prices. Additionally, she believes the Fed’s tightening cycle is nearing its end, which supports the TIPS market. The recent rise in real yields has put pressure on financial conditions, leading Falconio to anticipate a reversal in the outflow of TIPS funds seen over the past year.

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