I am struggling with understanding the difference in yields between nominal bonds and inflation-adjusted bonds.
With inflation adjusted bond like TIPS, every coupon payment in addition to the face value is adjusted for inflation in accordance with increases in CPI. With nominal bonds like treasuries inflation is not considered when the issuer makes payments to the bond holder.
I am confused because nominal bond yields rise when the market anticipates a rise in inflation. I view that as investors simply increasing the discount rate when valuing the bond, decreasing the price of the bond and increasing the YTM.
If the above is true true, then don’t nominal bond yields already account for the market’s expected rise in inflation? How then do TIPS provide any benefit?
Maybe my misunderstanding comes from not really understanding how TIPS work? Please help!