A Blend of Real and Nominal Yields to Balance Risk — Evening Brief – 02.24.25

Amid ongoing inflation concerns, the relatively strong real yields from inflation-linked US Treasurys may offer a sense of assurance for investors uneasy about price increases.

Looking at the 5- and 10-year yields of US Treasury Inflation-Protected Securities (TIPS) as benchmarks, the market is providing real returns near the peak levels seen over the last 16 years. But is this an opportunity that is too enticing to overlook?

To evaluate whether it makes sense to secure these real yields now, consider that while real yields aren’t at their recent highs, they’re still notably elevated compared to much of the past 15 years.

As of February 24, the 10-year real yield sits at 2.05%, just above the 5-year yield of 1.68%, according to Treasury.gov figures. By purchasing TIPS at these rates and holding them, you lock in those returns through maturity. For example, acquiring a 10-year TIPS secures a 2.05% real yield over the coming decade.

One way to judge if these real yields are compelling is to compare them to nominal yields. Currently, US 5- and 10-year maturities are offering 4.34% and 4.50%, respectively. The key issue is whether it’s the right moment to commit to either a higher nominal or real yield. The decision, however, remains unclear, as both yields and inflation are subject to change, and forecasting their trajectory or scale is impossible.

If you opt for a standard 10-year Treasury, you’ll secure a 4.50% yield, which is 2.45 percentage points above the 10-year real yield. Does the elevated nominal yield make it the better choice?

Should inflation average 2.45% over the next decade, the nominal and real 10-year Treasuries would deliver roughly equivalent outcomes. Interestingly, the 2.45% gap between the nominal and real 10-year yields reflects the market’s implied inflation expectation. The pivotal question is whether your inflation prediction deviates from the market’s estimate.

This brings up another consideration: How do you see nominal and real yields evolving moving forward? For instance, holding TIPS ensures a steady real yield until maturity, but the nominal yield could swing widely from today’s levels. This introduces a psychological risk—you might be content with the current real yield but later feel let down by the nominal yield’s performance.

For an investor agnostic about inflation, a mixed approach—splitting funds between TIPS and nominal Treasuries—could balance the risks. Ultimately, it’s less about finding a “perfect” answer and more about aligning the choice with your risk tolerance and expectations. What’s your personal inflation forecast, and how does it shape your leanings here? At a time of increased uncertainty about inflation, the relatively elevated real yields available in inflation-indexed Treasuries may offer a partial antidote of certainty for anxious investors.