Weiss Ratings backs 5-year TIPS as oil surge raises inflation risk

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Weiss Ratings backs 5-year TIPS

Highlights

Brent crude closed above $112 a barrel and September fuel oil prices rose 74% year-over-year, lifting U.S. consumer price inflation to 3.7%.
The five-year TIPS breakeven inflation rate rose to 2.45% as nominal Treasury yields fell and Weiss Ratings sees inflation protection as relatively cheap versus nominal bonds.
Weiss Ratings rates Travelers A+ and Chubb A after investment income rose 7% and 6.3% respectively in Q3, favoring five-year TIPS over long-term bond funds or Series I savings bonds.

Inflation hedge case strengthens

As reported by Weiss Ratings, Brent crude closed above $112 a barrel on Thursday, its highest finish in about five months, while the 10-year Treasury yield fell below 5% in its biggest one-day drop since March 2023.

The report says the market move reflects risk aversion rather than confidence that inflation is easing. It points to tanker damage in the Strait of Hormuz and attacks on Saudi targets as drivers of the oil jump, while noting that September fuel oil prices were up 74% from a year earlier and gasoline prices were up 34%. Consumer prices rose 3.7% in the year to September, even as the Federal Reserve, Fed, raised rates at its last meeting to push inflation lower.

Weiss Ratings says Thursday's Treasury rally is tied to a broader flight to safety after a 2.6% drop in the Nasdaq and concerns over artificial intelligence, AI, spending. It notes that the five-year breakeven inflation rate, the gap between nominal Treasury yields and TIPS yields, rose to 2.45% by Thursday's close from 2.40% on Wednesday, suggesting investors modestly increased their inflation expectations even as nominal yields fell.

The note argues that this leaves inflation protection looking relatively cheap. A five-year TIPS paid 2.55% above inflation on Wednesday, compared with 4.95% for a regular five-year Treasury, meaning the inflation-linked bond comes out ahead if inflation averages more than 2.40% over five years.

Bond and insurer implications

Weiss Ratings warns against extending too far out the curve after the Treasury rally, saying long-term bond buyers remain exposed if yields move back up as market fear fades and oil stays elevated. It gives the iShares 20+ Year Treasury Bond ETF a D rating, or SELL, and says the iShares TIPS Bond ETF also earns a D+ because its mix of maturities and constant portfolio turnover leave investors exposed to price swings.

The report favors holding an individual TIPS to maturity over owning a fund, because the investor receives inflation-adjusted principal back regardless of interim market volatility. It also says Series I savings bonds bought through Oct. 31 pay a fixed rate of 0.90% above inflation, below the level available on a five-year TIPS, though it notes Tipswatch expects a higher fixed rate from Nov. 1.

Beyond bonds, Weiss Ratings says insurers stand to benefit from higher yields because they invest premium income before claims are paid. It rates Travelers A+, or BUY, citing a 7% rise in after-tax investment income in the third quarter, and rates Chubb A, or BUY, after the insurer posted a record level of adjusted investment income, up 6.3% in the quarter.

The report concludes that investors putting new money into fixed income should prefer a five-year TIPS for funds they can leave untouched for five years, while keeping cash needed in the near term in six-month Treasury bills. It says the combination of elevated energy prices and subdued market inflation pricing supports owning direct inflation protection now.

In our earlier article on conflict-driven spikes in oil shipping costs, we explained how attacks and rerouting risks around chokepoints such as the Strait of Hormuz and the Red Sea sent tanker freight rates sharply higher. We noted that these transport and insurance premiums can quickly feed into gasoline and broader consumer prices, amplifying inflation pressure even when crude prices themselves are only part of the story.

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