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Treasury Inflation Protected Securities, better known as TIPS are all the rage these days and should be, given their stellar returns (more than 6% since the start of the year versus roughly 4% on plain treasuries). In effect, these instruments are the equivalent to plain vanilla treasuries but carry even lower risk given that they protect the holder from the corrosive effect of a surge in inflation which is accomplished by adjusting the nominal value at maturity by changes in the broad measure of the CPI index. The inflation hedge explains why yields are below those of standard treasuries.
TIPS which were introduced in 1997 are also an important measuring tool for inflation expectations. One looks at the spread and the change in spread between the treasury yield curve and that of TIPS to get a feel of inflation expectations. Like with an ordinary bond, if the yield (or real yield in parlance terms) remains the same, the bond price doesn't budge. But if there is a shift in inflation perception, price movements occur (like we have seen over this year and last).
With a steepening yield curve and the performance in TIPS and commodities in general, the market is telling us that the risk of inflation on the horizon is rising. It is no wonder given the aggressive cut in rates over the past weeks and months. But then we have a lag factor of between 6 and 8 months from the moment a change in rates takes place and it's effects begin to appear in economic releases. This means that the Fed is playing a very delicate balancing act whereby as soon as it feels confident enough that the conundrum has subsided for good, they will have to aggressively tighten to avert inflation from getting out of hand. In the mean time, having some form of hedge against inflation in one's portfolio should be considered as a sound proposition.