Why Are The Prices Of TLT & TIP Going In Different Directions If They're Both Treasury Bond ETFs?

eternal student answered:
They are both Treasury bonds but one is inflation protected the other is not. Therefore, they are subject to different set of factors that drive their volatility.

As you know, for a regular bond, coupon rate and the principal or face value are fixed at issue. If the required yield for the long term bond (TLT) changes, the market price of the bond will change. The required yield on a long-term risk-free government bond is real rate + expected inflation. As expected inflation changes, the required yield will change, and thus the price of the bond will change. There are other factors such as flight-to-quality etc. which we can ignore for simplicity. The real interest rate depends on long-run economic factors and doesn't change often. Thus expected inflation drives 80% of the volatility of long-term bonds such as those included in the TLT.

Now as you know, TIPS is by design inflation protected. Coupon rate is fixed at issue. But the principal is semi-annually adjusted for inflation. Thus the coupon rate reflects the "real rate." Then by definition, TIPS should not go up or down by changes in expected inflation. (Since it is only adjusted semiannually, it does vary a little by changes in actual inflation or the anticipated next adjustment as explained in the previous answer, we can ignore this effect for simplicity). That means you have taken away the factor - expected inflation - that drives 80% of the volatility of long term bonds (TLT).

This means only the "other factors" such as change in real interest rate are responsible for most of the volatility in TIPs. Whereas for a TLT these other factors drive only roughly 20% of the volatility. Hence, TIP and TLT do not always move together (showing lower correlation).

On a related note, since the yield on the TIPS is a measure of real rate, the spread between the yield on the TIPS and regular bond is taken as a measure of expected inflation signaled by the bond market.

Dhiraj Shekar answered:
A TLT invests in treasury bonds which pay back regular and fixed coupon payments. So during periods of inflation, the nominal interest rate changes and the bond prices come down. This is because, if the coupon payment is 3% and if inflation has caused the nominal rate of interest to go up to, say, 3.5%, there would be less no. of buyers for a bond that offers a coupon payment that is lesser than market interest rates. This causes the price of TLT to go down. Whereas, on the other hand, TIP invests in Treasury Inflation Protected Securities (TIPS). The actual principal of a TIP is tied to inflation. If inflation increases, the principal also increases and even though the interest rate on a TIPS in fixed, due to the variable nature of the principal, the amount that is paid back to the investor increases with the inflation. This increase in the rate of return on a TIP would cause more demand and will eventually increase its price. The converse would be true during deflation.

Clark Kent answered:
TLT is a long-term bond and interest rates are going to move in inverse relation to interest rates, going up when rates drop and vice versa.

TIPs move based on inflation and deflation. They have been selling at a discount by pricing in anticipation of deflation. It is confusing but that is the best I can tell from what I've read and which does not explain it very clearly.