What is the relationship between the price of TIPS bonds and inflation expectations?
I reflect thаt usually whеn inflation іѕ expected, thеn regular bond prices gο down, bυt ѕіnсе TIPS bonds аrе adjusted fοr inflation, іѕ thе relationship different?
BTW, I’m interested іn bond prices, nοt yields.
Yes. The principal amount of TIPS is adjusted for inflation. Thus the coupon rate for TIPS represents real interest rates.
a) TIPS price will go down when real interest rate goes up.
b) Real interest rates don’t change often. Nominal interest rates change often, with expected inflation driving 80% of the volatility in nominal interest rates. When expected inflation rises, nominal interest rates rise and regular bond prices go down. As for TIPS, the principal will be adjusted only semi-annually based on “actual” inflation. So TIPS price today will go up in anticipation of the next upward adjustment of principal. This price adjustment is in the opposite direction of the regular bond. Therefore, TIPS returns will have very low correlation with regular bond returns.