The TIPS Spread is a simple comparison between the yield of Treasury Inflation Protection Securities (TIPS) and the yield of conventional U.S. Treasuries with the same maturity date.
The TIPS Spread is jam packed with important inflation information. According to the Federal Reserve Bank of San Francisco:
"In principle, comparing the yields between conventional Treasury securities and TIPS can provide a useful measure of the market's expectation of future CPI inflation. At a basic level, the yield-to-maturity on a conventional Treasury bond that pays its holder a fixed nominal coupon and principal must compensate the investor for future inflation. Thus, this nominal yield includes two components: the real rate of interest and the inflation compensation over the maturity horizon of the bond. For TIPS, the coupons and principal rise and fall with the CPI, so the yield includes only the real rate of interest. Therefore, the difference, roughly speaking, between the two yields reflects the inflation compensation over that maturity horizon."
The wider the spread between the two yields, the higher investors' expectations are.
The narrower the spread between the two yields, the lower investors' expectations are.
However, in reality the TIPS spread also captures a risk premium from the conventional Treasury security, and a liquidity premium from the TIPS. The Federal Reserve Bank of Cleavland use to calculate the two in order to produce a more accurate measure of inflation expectations, but stopped in October of 2008, being unable to accurately calculate liquidity premiums during such turbulent times.