Why TIPS can lose value even when inflation rises

A nominal Treasury note has fixed principal—the face amount, also called par—and pays interest at a set rate on that amount. Treasury Inflation-Protected Securities, or TIPS, change the payment base: their principal adjusts with inflation.315

That adjustment can increase principal and interest dollars while resale value falls if buyers demand higher real yields, meaning greater inflation-adjusted returns. These outcomes can coexist because Treasury’s payment promise and a buyer’s valuation answer different questions. Inflation does not necessarily cause real yields to rise.14

Inflation changes the payment base, not the coupon rate

Treasury uses the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers, or CPI-U, published monthly by the Bureau of Labor Statistics. CPI tracks average price changes for a representative basket of consumer goods and services. Principal rises with inflation and falls with deflation. Slower positive inflation still means prices are rising; it does not mean the price level has fallen. The coupon rate—the annual interest percentage—remains fixed. Payments come every six months, so a fixed percentage applied to a larger principal produces more interest dollars.2163

Treasury’s educational example, not a current quote, starts with $1,000 in a five-year TIPS with a 0.125% annual coupon. The index ratio, the multiplier applied to original principal, is 1.01165. That produces adjusted principal of $1,011.65. For the six-month payment, Treasury applies half the annual coupon rate, 0.0625%, to that adjusted amount. Its published interest payment is $0.63. The rate stays fixed while the dollar base changes.3

Why higher real yields can reduce resale value

A buyer asks what return the remaining payments offer at the purchase price. Yield to maturity expresses an annual return accounting for interest and redemption, the principal payment when the security comes due. Paying less for the same remaining payments offers a higher yield: the buyer commits fewer dollars to obtain them. The coupon sets the payment rule; yield relates payments to cost. Treasury’s pricing explanation accordingly allows prices above or below par.32

For TIPS, the relevant required return is measured after inflation. When required real yields rise, valuations generally fall. Inflation adjustment does not remove that price response: it changes the payments being valued, while the required yield changes what buyers will pay for them. An increased indexed balance therefore cannot, by itself, establish the proceeds available from selling.41

What the maturity floor actually protects

At maturity, Treasury redeems a TIPS at the greater of adjusted principal or par at original issue. Three amounts matter here: original-issue par, principal after index adjustments and the investor’s purchase cost. The floor compares the first two. Purchase cost does not replace original par in that comparison, so the floor cannot guarantee recovery of every price paid. It also does not set a minimum price for an earlier sale.2

Even a fund with an end date illustrates the boundary. The February 27, 2026 prospectus for the iShares iBonds Oct 2033 Term TIPS ETF schedules termination around October 15, 2033, distributing remaining net assets. It promises no predetermined payout or principal guarantee for shares. A termination date supplies a timetable, not a fixed account balance. The disclosure also says inflation-indexed securities can earn less than conventional bonds.4

Breakeven inflation and other limits

Yield spreads and inflation expectations are distinct. Subtracting a TIPS yield from a nominal Treasury yield of comparable maturity gives inflation compensation, often called breakeven inflation. Matching maturities keeps the comparison focused on the same investment horizon. In the Fed authors’ model, the gap equals expected inflation plus inflation-risk compensation minus a TIPS liquidity premium.5

Inflation-risk compensation is the extra return nominal-bond investors demand for bearing inflation uncertainty. The TIPS liquidity premium reflects their relative difficulty of trading compared with nominal Treasuries, along with other supply-demand influences. The subtraction matters: a premium that raises TIPS yields narrows nominal-minus-TIPS yields. The gap therefore contains more than an inflation forecast; changes in those other components can change it too.5

For a household, the benchmark also matters. BLS explains that someone allocating an above-average budget share to medical care may experience higher inflation than CPI when medical costs rise faster than other prices. Both the prices that change and the share of spending exposed to them matter. An adjustment matching the national basket therefore need not match the increase in a particular household’s bills.6

There is also a cash-timing limit. Treasury says interest generally is taxable when received; principal inflation adjustments are taxable in the year they occur, although paid at maturity. An increase in indexed principal can consequently have a tax effect before that increase arrives as cash.2

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