NEW YORK–A study released today by the Federal Reserve Bank of New York provides new evidence on the liquidity of Treasury inflation-protected securities (TIPS) and how it differs from that of nominal Treasury securities. The study, "The Microstructure of the TIPS Market," is the latest article in the New York Fed’s Economic Policy Review series.
Authors Michael J. Fleming and Neel Krishnan explain that the expected benefits from the Treasury’s introduction of TIPS in 1997 have yet to be fully realized, mainly because the securities are less liquid than nominal Treasuries. The relative lack of liquidity is thought to result in TIPS yields having a liquidity premium compared with nominal Treasuries, a factor that offsets the advantages of TIPS having no inflation risk.
Despite the importance of TIPS liquidity and the market’s large size–$728 billion in November 2011--there is hardly any quantitative evidence on the securities’ liquidity. The authors note that published Federal Reserve data show trading activity in TIPS to be much lower than activity in nominal securities. But the Fed data are aggregated over the week and across all TIPS and cover only trading volume. The data therefore do not provide information about activity in particular TIPS, activity over the day or week, or other measures of liquidity, such as bid-ask spreads.
In contrast, Fleming and Krishnan use more granular “tick” data from the interdealer market to characterize the liquidity of the TIPS market. They identify several features of that market also present in the nominal securities market, but some unique features as well. In both markets, there is a significant difference in trading activity between the most recently issued (“on-the-run”) and previously issued (“off-the-run”) securities, as trading drops sharply when securities go off the run. In the TIPS market, there is little difference in bid-ask spreads or quoted depth between securities, but large variation in the incidence of posted quotes. These results lead Fleming and Krishnan to conclude that “trading activity and the incidence of posted quotes may be better cross-sectional measures of TIPS liquidity than bid-ask spreads or quoted depth.”
The study also analyzes the effects on TIPS liquidity of intraday trading activity patterns and public announcements (the CPI release, employment report, FOMC post-meeting announcement, and TIPS auction results). Intraday trading patterns are found to be broadly similar in both markets, but TIPS activity peaks somewhat later--likely reflecting differences in the use and ownership of the securities. Announcement effects differ between markets, with TIPS auction results and CPI releases eliciting especially strong increases in trading activity, “likely indicating these announcements’ particular importance to TIPS valuation.”
Michael J. Fleming is a vice president at the Federal Reserve Bank of New York; Neel Krishnan is a former research associate at the New York Fed.