Opinion: Inflation report brings 2 pieces of good news for retirees and retirement savers

Retirees and those seeking secure income got two items of very good news this week, although you may only have heard about one.

July’s inflation came in below fears (although a debate now rages on what the “real” inflation rate is—more on that below).

Meanwhile, your ability to earn a guaranteed rate of return on risk-free investments, regardless of what happens to inflation, actually went up.

So-called TIPS bonds, Treasury bonds protected against inflation, fell slightly in price this week. And as a result the interest rates available for new buyers went up. (Bonds work like seesaws: When the price falls, the “yield” interest rate rises.)

A 5-year TIPS bond is now guaranteed to beat inflation by 0.3% a year between now and 2027, no matter what inflation turns out to be, and a 30-year TIPS bond is guaranteed to beat inflation by nearly a full percentage point per year. That’s equivalent to a 35% rise in purchasing power between now and 2052.

What is going to happen to inflation over that time? I have no idea. Nor does anyone else. Some extremely smart and experienced financial wizards—including fund managers David Einhorn at Greenlight Capital and Jonathan Ruffer in London—think that inflation is going to rise, and keep rising. Einhorn recently suggested that the recent fall in inflation, to borrow last year’s word, is likely to prove “transitory.”

Could they be right? President Biden boasted this week that the inflation was now down 0%, but at the same time he pointed out on Twitter that the jobs market is booming and workers have bargaining power they haven’t had in decades—meaning that wages are likely to go up.

Rising wages wouldn’t be inflationary if they were matched by rising productivity, but unfortunately the latest data show that labor productivity has plunged this year.

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So the people saying inflation hasn’t gone away may not be crazy.

On the other hand, you have to wonder about all those millions of people who are, perhaps unwittingly, taking a big gamble the other way.

That includes anyone owning regular or nominal Treasury bonds. If you are a retiree or a low-risk investor, and you own the standard kind of lower risk or balanced portfolio, that probably includes you.

The standard (non-inflation-protected) 5 year Treasury note yields about 3%. The 10 year yields less, around 2.9%. The 30 year is only slightly above 3%. Those yields make sense only if you believe that inflation has collapsed and will continue to collapse.

I have written here before about the so-called “breakevens,” a technical measure in the bond market that effectively anticipates future inflation. Right now the 5 year break-even is about 2.7% and the 10 year is about 2.5%. What this means is that anyone owning a 5 year regular Treasury bond, instead of a 5 year TIPS bond, is unwittingly making a bet that inflation over the next 5 years will average less than 2.7% a year. Anyone owning a 10 year regular Treasury bond, instead of the 10 year TIPS bond, is betting that inflation will average less than 2.5% between now and 2032.

That’s quite a bet.

It is a mystery to me why these traditional or old-fashioned Treasury bonds are still considered “risk free” assets. They only pay out nominal interest rates. Buy a bond paying 3% a year for 10 years and see how risk-free that is if inflation comes in at 10% a year.

It is, frankly, hard to see much upside in buying traditional bonds over TIPS. Even if inflation comes in low, how low is it going to be? And do you really want to be making bets with your retirement account?

Meanwhile, in case you missed it, the last few days have seen one of those political debates about the “real” inflation rate. The president, backed by his official spokesperson, has argued it’s really 0% because prices didn’t move between June and July. His critics have argued that the real rate is 8.5%, because that’s the change in prices in July from a year earlier.

I’m not unsympathetic to the case for looking at the most recent monthly price rise. It is, after all, the latest date. But extrapolating from that to “inflation is 0%” is the kind of public relations stretch that turns a good data point into a punchline.

Meanwhile, I have a suggestion.

To all those people now cheering that the true rate of inflation is now 0%, go bet on it. Go out and buy zero coupon 30 year bonds, locking in 3.1% interest per year between now and 2022 and 2052. If you’re right, you’ll make out like bandits.

Good luck.

Meanwhile, if you live in the real world and you pay real prices in real stores, and you don’t feel much like gambling your life savings on future economic indicators, TIPS bonds over regular Treasurys looks like an easy choice to me.

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