Exhibit I: A table displaying real yields and breakevens at two-, five-, 10-, and 30-year intervals for inflation-indexed markets as of December 31, 2024.
4Q Highlights
|
Paused
As 2024 entered its final quarter, investors adjusted to economic dynamics and Federal Reserve (Fed) policy. The Fed has cut rates 100 bps since September, but it signaled a pause in further rate cuts during its December meeting. The shift reflects stronger-than-expected economic growth and slower progress in inflation’s return to target. Intermediate- and long-maturity real yields increased in the quarter and for the year. Including 2024, Treasury Inflation-Protected Securities (TIPS) outperformed nominal Treasuries in five of the last six years. In our final update of the year, we review inflation markets, portfolio positioning, performance, and the economic context as we enter 2025 with Fed policy on pause.
Market update
In the fourth quarter of 2024, long-maturity real yields sold off more than 50 bps, while shorter maturities rallied about 20 bps. The steepening of the curve restored its familiar upward-sloping shape. For the year, long-maturity real yields sold off more than 50 bps, while short-maturity real yields rallied 60 bps. A stronger-than-expected economy and slower progress with inflation returning to the Fed’s 2% target drove market-implied inflation expectations (breakevens) higher in the quarter, pushing shorter maturities over long maturities. Two-year breakevens increased almost 80 bps, while 10-year and longer maturities increased around 15 bps. (See Exhibit I.)
Considering the Fed eased its policy rate 100 bps since September, it is ironic that longer-maturity yields sold off in the subsequent quarter, in stark contrast with the early stages of previous easing cycles. A few factors explain this response:
1. From May to September, real rates rallied for five consecutive months as investors priced in aggressive Fed easing.
2. In late September and October, as the likelihood of a Trump presidency increased, campaign promises deemed inflationary — such as tariffs on imported goods and strict immigration — exerted further upward pressure on rates.
3. The selloff continued until late November when Trump nominated Scott Bessent (perceived to be more moderate and market friendly) as the next Treasury Secretary. Rates rallied briefly but resumed their upward trajectory in December after a strong labor market report and the Fed signaled a pause in the easing cycle.
TIPS returned -2.88% in the fourth quarter, bringing returns for the full year to +1.84%. Since breakevens remained below realized inflation in 2024, inflation accruals helped TIPS outperform nominal Treasuries by +1.2%. TIPS also outperformed the Bloomberg Aggregate Bond Index (Agg) by +0.47% in 2024.
Positioning and performance
Our TIPS portfolios hold 10 to 15 securities — labeled as Holdings in Exhibit II — out of dozens in the Bloomberg U.S. Treasury Inflation-Linked Index. As the real yield curve normalized in the quarter, we gradually realized profits on our steepener position and allocated more toward intermediate maturities to benefit from roll-down opportunities. Our duration allocation increased briefly after a sharp post-election selloff but returned to a mild overweight by year-end.
Exhibit II: Two charts displaying the TIPS portfolio positioning as of December 31, 2024, where allocation shifted more toward intermediate maturities.
For the year, our TIPS portfolios outperformed their benchmarks by 12 to 14 bps. Security selection and duration were the main contributors. Our real yield curve steepener detracted from performance in the summer, when the curve flattened, but as it returned to its traditional upward-sloping shape in Q4, the steepener erased the earlier losses and finished the year even.
The economy and Fed policy
Economic growth maintained a steady pace in the fourth quarter, defying expectations of an impending slowdown. High-frequency measures of economic growth, such as the Atlanta Fed’s GDPNow and the New York Fed’s Nowcast, suggest economic growth will remain between 2% and 3%. As the Fed lowered the policy rate, financial conditions eased further with the rally in equity markets, tighter credit spreads, and a stronger dollar. Against this economic backdrop, core inflation’s move toward the Fed’s 2% target stalled, leading the Fed to pause the easing cycle. By year-end, investors in fed fund futures expected less than two 25-bp cuts in 2025, a significant revision from the five cuts expected three months ago.
The December FOMC meeting delivered a hawkish message and the decision to cut was not unanimous. Cleveland’s Fed President dissented, and the Summary of Economic Projections (SEP) showed that three other committee members preferred to keep the policy rate unchanged. Furthermore, the SEP indicated the Fed revised its 2025 growth, inflation, and policy rate expectations by +0.1%, +0.4%, and +0.5%.
A busy hurricane season and a major Boeing strike distorted labor market indicators early in the fourth quarter, but subsequent numbers showed hiring returned to its previous trend. For the year, the economy added 2.1 million jobs at an average pace of 186,000 per month. The unemployment rate, which had ticked up last quarter, closed the year at 4.1%, almost 2% below the 60-year pre-pandemic average of 6%. Wage growth edged down, with the Atlanta Fed’s wage tracker now at 4.2% and average hourly earnings, published by the Bureau of Labor Statistics, at 3.9%.
Core inflation, measured by the annual change in personal consumption expenditures (core PCE), the Fed’s preferred measure of underlying inflation, reached 2.8%, an increase of 0.2% since June. Annual headline inflation, measured by the change in the Consumer Price Index (CPI), reached 2.8%, while core CPI inflation remained around 3.2% since July (see Exhibit III-a). Although the goods sector has contributed more to core CPI inflation in recent months, the services sector remains the main driver (Exhibit III-b). The cost of shelter, which approximates rent expenditures and accounts for more than 40% of core CPI, has not moderated enough to bring core inflation below 3%.
Exhibit III(a): A chart displaying the change in annual inflation as measured in the Headline CPI, Core CPI, and Core PCE as of December 31, 2024.
Exhibit III(b): A chart displaying contributions to Core CPI by sector as of December 31, 2024: Goods contributed, but services remained the main driver.
It is too soon to tell the impact of the policies promised by the incoming Trump administration. Aggressive tariffs and strict immigration restrictions have the potential to hurt economic growth and increase prices. Furthermore, additional tax cuts could exacerbate already significant fiscal deficits. For these reasons, our baseline expectation is that only moderate versions of campaign promises will be implemented.
TIPS historical performance
TIPS have been a reliable source of excess return over nominal Treasuries. An analysis of relative performance since 1998, the first full year with TIPS in existence, shows they outperformed nominal Treasuries by an average 1.1% per year. Moreover, TIPS outperformed the Bloomberg Aggregate Bond Index (Agg) by 0.8% on average.
Exhibit IV: A table displaying TIPS excess return as of December 31, 2024, where TIPS outperformed nominal Treasuries and the Bloomberg Aggregate Bond Index.
During the inflation surge, realized inflation built into TIPS returns provided excellent protection to investors. TIPS outperformed nominal Treasuries, the Agg, and corporate bonds in 2020 through 2022. This raises the question: Will TIPS perform well in a world with stable prices? Note that in addition to hedging inflation, TIPS act as a quality hedge as well. Exhibit IV shows that in years dominated by flight-to-quality episodes (e.g., 2008, and 2018), TIPS underperformed nominals but outperformed corporate bonds. In risk-on years (e.g., 2009, 2019, and 2024), TIPS outperformed nominals but underperformed corporate bonds. A somewhat unique aspect of TIPS is that they are government securities that carry a small liquidity premium over nominal Treasuries. Hence, they often move with risk assets, outperforming nominals in risk-on periods, and underperforming nominals in risk-off periods while staying ahead of credit.
Conclusion
The performance of TIPS over the years highlights their .dual role as an inflation hedge and as a solid alternative during periods of uncertainty. While 2025 remains uncertain, with steady economic growth, inflationary pressures lingering, and the Fed’s easing cycle paused, TIPS continue to offer compelling value for investors seeking both inflation protection and quality exposure. As we navigate the implications of the incoming administration’s policies, maintaining a disciplined approach to portfolio positioning and adapting to changing market conditions will be key. Looking ahead, TIPS remain a core component of a well-diversified fixed income strategy, offering protection and performance through a range of economic scenarios.
| Performance As of December 31, 2024 |
|||||||
|---|---|---|---|---|---|---|---|
Composite/Benchmark |
3 Mo. |
YTD |
1 Yr. |
3 Yr. |
5 Yr. |
10 Yr. |
Since Inception |
BBH Inflation-Indexed Securities Composite (Gross of Fees) |
-2.90% |
1.95% |
1.95% |
-2.29% |
1.80% |
2.29% |
4.97% |
BBH Inflation-Indexed Securities Composite (Net of Fees) |
-2.94% |
1.80% |
1.80% |
-2.44% |
1.65% |
2.14% |
4.82% |
Bloomberg U.S. TIPS Index |
-2.88% |
1.84% |
1.84% |
-2.30% |
1.87% |
2.24% |
4.65% |
| Returns are not annualized. The Inflation-Indexed Fixed Income Composite inception date is 04/01/1997. Past performance does not guarantee future results. Source: BBH & Co. and Bloomberg Data presented is that of a single representative account (“Representative Account”) that invests in the strategy. It is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the Inflation-Indexed Fixed Income Strategy. |
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1 Basis points (bps) is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument.
RISKS
The value of the portfolio can be affected by changes in interest rates, general market conditions and other political, social and economic developments. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.
Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, maturity, call and inflation risk; investments may be worth more or less than the original cost when redeemed. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices.
Foreign investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.
The Strategy may also invest in derivative instruments, investments whose values depend on the performance of the underlying security, assets, interest rate, index or currency and entail potentially higher volatility and risk of loss compared to traditional bond investments.
Holdings are subject to change. Totals may not sum due to rounding.
The Bloomberg U.S. TIPS Index includes all publicly issued, U.S. Treasury inflation-protected securities that have at least one year remaining to maturity, are rated investment grade, and have $250 million or more of outstanding face value. The index is not available for direct investment.
“Bloomberg®” and the Bloomberg indexes are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indexes (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Brown Brothers Harriman & Co (BBH). Bloomberg is not affiliated with BBH, and Bloomberg does not approve, endorse, review, or recommend the BBH Strategy.
Effective duration is a measure of the portfolio’s return sensitivity to changes in interest rates.
Credits: Obligations such as bonds, notes, loans, leases and other forms of indebtedness, except for Cash and Cash Equivalents, issued by obligors other than the U.S. Government and its agencies, totaled at the level of the ultimate obligor or guarantor of the Obligation.
Data presented is that of a single representative account (“Representative Account”) that invests in the strategy. It is managed with the same investment objectives and employs substantially the same investment philosophy and processes as the Inflation-Indexed Fixed Income Strategy.
Brown Brothers Harriman Investment Management (“IM”), a division of Brown Brothers Harriman & Co (“BBH”), claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.
To receive additional information regarding IM, including a GIPS Composite Report for the strategy, contact John W. Ackler at 212 493-8247 or via email at john.ackler@bbh.com.
Gross of fee performance results for this composite do not reflect the deduction of investment advisory fees. Actual returns will be reduced by such fees. Net of fees performance results reflect the deduction of the maximum investment advisory fees. Returns include all dividends and interest, other income, realized and unrealized gain, are net of all brokerage commissions, execution costs, and without provision for federal or state income taxes. Results will vary among client accounts. Performance calculated in U.S. dollars.
The objective of our Inflation-Indexed Fixed Income Strategy is to deliver excellent returns in excess of industry benchmarks through market cycles. The Composite included all fully discretionary, fee-paying domestic accounts over $10 million with an emphasis on U.S. inflation indexed securities. May invest up to approximately 25% outside of U.S. inflation indexed securities, and a duration of approximately 7-9 years. Accounts that subsequently fall below $9.25 million are excluded from the Composite.
Brown Brothers Harriman & Co. (“BBH”) may be used to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2024. All rights reserved.
Not FDIC Insured No Bank Guarantee May Lose Money
IM-15876-2025-01-21 Exp. Date 04/30/2025
