Here's why it's time to buy this inflation-protected investment, UBS says

Published Thu, Aug 24 20231:01 PM EDTUpdated Thu, Aug 24 20231:16 PM EDT

UBS has gotten bullish on 5-year Treasury inflation-protected securities. The Wall Street firm upgraded the 5-year securities, known as TIPS, to most preferred from neutral on Wednesday. The yield on 5-year TIPS hit 2.24% on Wednesday, the highest real yield the sector has seen in over 15 years, said Leslie Falconio, head of fixed income strategy in UBS Americas' chief investment office. The yield eased slightly Thursday and was last at 2.15%. Bond yields move inversely to prices. "While we cannot say that this is the high in real yields over the next two months, we do feel confident that real yields will trend lower at year-end and into 2024," Falconio wrote in a note to clients. US5YTIPS YTD mountain Yields on 5-year TIPS Investors worried about rising prices began flocking to TIPS in 2021 to protect against inflation. The principal portion of the securities rise and fall alongside the movement in the consumer price index. However, investors fled TIPS in 2022 when they bet on the success of the Federal Reserve in slowing the pace of inflation. While inflation expectations are a driver of performance, so are U.S. nominal interest rates, Falconio explained. TIPS yields account for inflation, but Treasury yields are nominal and don't take inflation into account. "While investors were confronted with historically high inflation, TIPS proved to be a disappointment as the interest rate component dramatically underperformed," she said. Real yields are now rising over optimism that the Fed will be successful in avoiding a recession in the coming quarters and that it will be able to keep rates higher for longer, Falconio said. Those higher real yields also have been a contributor to rising nominal yields, she said. "This shift to a more hawkish Fed path is now priced into the market, creating a more attractive entry point as it relates to the interest rate component of TIPS performance," she wrote. "While inflation is expected to continue its downward trend, the inflation risk premium remains in positive territory." Falconio specifically likes the 5-year TIPS not only for its yield, but because it is more heavily influenced by short-term sentiment, like shifting monetary policy or the price of oil. "And while we believe the Fed is holding a higher-for-longer stance, we also believe it is nearing the end of its tightening cycle, supporting the TIPS market (tightening is a headwind to inflation)," she said. "While lagged, the large rise in real yields will take a toll on financial conditions, and we believe the outflow of TIPS funds over the past year will reverse." — CNBC's Michael Bloom contributed reporting.