TIPS in the Crossfire: Can Bessent's Fiscal Strategy Undermine Their Value?

Inflation-Protected Securities (TIPS) have long been a bedrock of conservative portfolios, shielding investors from rising prices by tying principal and interest payments to the Consumer Price Index (CPI). But as Scott Bessent, Donald Trump's Treasury Secretary nominee, pushes policies framed as a “detox” for the U.S. economy, the calculus for TIPS investors grows murkier. Bessent's vision—combining deficit reduction, tariff-driven trade leverage, and fiscal austerity—poses a direct challenge to the premise that inflation remains a persistent threat. Here's why investors must parse his claims carefully.

Bessent's Claims: A Roadmap for Lower Inflation?

Bessent's policies hinge on two core ideas: deficit reduction as a debt brake and tariffs as a strategic tool to reshape trade dynamics. Both aim to moderate inflation, but their execution carries risks—and implications for TIPS.

1. Deficit Reduction: Fiscal Austerity or Growth Drag?

Bessent advocates extending Trump's 2017 tax cuts while slashing federal spending to offset the costs. His logic: reducing the deficit will curb inflationary pressures by shrinking government borrowing and redirecting capital to the private sector.

This approach assumes that lower deficits automatically mean lower inflation. Yet history is less kind to austerity-driven disinflation. For instance, the 1990.0s Clinton-era surpluses coincided with low inflation but also relied on a tech-driven productivity boom—an uncertain parallel today. If Bessent's spending cuts stifle growth, inflation could fall below expectations, making TIPS' inflation-adjusted returns less attractive.

2. Tariffs: A One-Time Adjustment or Persistent Cost?

Bessent dismisses concerns that tariffs are inflationary, calling them a “one-time price adjustment.” He argues tariffs on Chinese imports will force fairer trade terms and fund tax cuts for Americans.

The data tells a mixed story. While tariffs initially spiked prices of goods like steel and electronics, broader inflation has been driven more by oil, housing, and labor costs. If Bessent's tariffs fail to alter trade dynamics and instead become a permanent tax on consumers, inflation could rise—bolstering TIPS. But if his strategy succeeds in reducing trade imbalances without raising prices, TIPS' appeal fades.

3. Economic “Detox”: Fiscal Purge or Overreach?

Bessent frames his policies as a “detox” to eliminate “steroid-fueled” debt-driven growth. By reducing federal spending, he aims to cool demand and shift growth toward manufacturing and national security sectors.

This vision assumes private-sector dynamism can offset fiscal contraction—a gamble. If growth slows too much, deflation risks could emerge, making TIPS' inflation link a double-edged sword. Their principal would grow less, but their real yield (currently around 1.8% for 10-year TIPS) might outperform cash in a low-inflation environment.

Valuation: Are TIPS Overpriced for a Lower-Inflation World?

Today's TIPS market already reflects moderate inflation expectations. The 10-year breakeven inflation rate—the gap between nominal Treasuries and TIPS yields—is around 2.1%, down from 2.8% in early 2023. This suggests the market already discounts some success for Bessent's policies.

But risks remain skewed against TIPS. If Bessent's austerity curbs inflation further, TIPS' real yields will rise (as prices fall), hurting holders. Conversely, if his tariff strategy backfires, or if geopolitical tensions spike energy costs, inflation could surprise to the upside—making TIPS a refuge.

Strategic Utility: TIPS as a Hedge, Not a Bet

Investors should treat TIPS as a diversifier, not a directional play on inflation. Their value lies in their ability to protect against unexpected inflation, not in guessing Bessent's policy outcomes.

• Hold TIPS if: You believe inflation risks are asymmetric—i.e., central banks might fail to control demand, or supply shocks resurface.
• Reduce exposure if: You trust Bessent's fiscal discipline will durably lower inflation and stabilize growth.

A prudent strategy: Maintain a small TIPS allocation (5-10% of fixed-income holdings) to hedge against inflation surprises, while rebalancing if breakeven rates fall further.

Final Take: Navigating Uncertainty

Bessent's policies are a high-stakes experiment. If successful, they could redefine the inflation narrative—but their success hinges on politically fraught spending cuts and tariff diplomacy. TIPS investors must weigh Bessent's vision against the market's already muted inflation expectations. For now, stay nimble: monitor the breakeven rate and TIPS' real yields, and adjust allocations as policy outcomes crystallize.

In a world where fiscal detox meets global uncertainty, TIPS remain a tool—not a panacea.