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Inflation Has Subsided, but for How Long?

Investors should take advantage of low TIPS prices as inflation abates.

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It is hard to believe that oil was $140 a barrel as recently as four months ago. Way back then, inflation was the front and center concern for most investors as the Consumer Price Index popped an amazing 1.1% in June alone. Times have certainly changed since then and the most recent CPI numbers showed an actual contraction (although very small) in prices. The source of this about face is obvious: Oil and commodities-not-named-gold have dropped precipitously in price, and assets like homes continue to lose value. The evidence clearly points to it being a deflationary environment in the short term.

So why on Earth would we recommend buying Treasury Inflation-Protected Securities if all the evidence points to deflation? For the simple reason that you should buy insurance before you need it, not when it is too late.

Take a look at the five-year chart below that compares monthly changes in annual CPI with the TIPS spread. The TIPS spread is the difference between TIPS yields and the corresponding Treasury yield. This is commonly referred to as the "inflation break even yield," meaning that as long as inflation is greater than the TIPS spread you are better off owning TIPS than Treasuries.

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Scott Burns does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.