Checking in on TIPS as quantitative easing ends (we hope)

A brief history. The Federal Reserve started its latest round of quantitative easing (QE3, in this case) on Sept. 13, 2012, when it launched a $40 billion per month program to buy mortgage-backed securities. This eventually morphed into ‘Operation Twist’ in December 2012 when the bond buying expanded to long-term Treasurys and bumped up to $85 million a month.

Fed balance sheet

SOURCE: Wall Street Journal

This launched a period of severely low interest rates, especially for Treasury Inflation-Protected Securities. On Sept. 17, 2012, I posted ‘Are TIPS a good investment in 2012?‘ which I answered with one word: No. (But then I rambled on, of course.)

On June 12, 2013, then-Fed-Chairman Ben Bernanke announced a ‘tapering’ of the bond-buying program, which finally ended this month. So for now, there technically is no active QE program, but the Fed continues to hold a massive portfolio of Treasurys and mortgage-backed securities, which at this point it can’t unload. This is from an excellent analysis in yesterday’s Wall Street Journal:

The central bank’s holdings of securities, loans and other assets have increased from $2.825 trillion when the program started to $4.482 trillion. The Fed has said it plans to maintain this level of holdings until after it starts raising short-term interest rates. Eventually, officials expect to reduce the holdings gradually by letting securities mature without reinvesting the proceeds.

What QE has meant for TIPS. My belief is that the September announcement of QE3 and the December 2012 expansion set up TIPS for a mighty fall in 2013. TIPS yields were already extremely low in mid-2013, and a new round of QE set off fears of future inflation, which bolstered the appeal of TIPS. Prices rose and yields fell.

Inflation, however, never became a factor, rising to just over 2% a year in early 2014 before slipping back down to 1.7%. So as the economy improved, and overall interest rates began rising in mid-2013, the appeal of TIPS was declining. A double whammy, resulting in a -8.65% drop in the TIP ETF in 2013.

This chart summarizes what has happened since QE3 was launched in September 2012:

QE ChangeThere are several striking statistics to consider in this chart:

  1. TIPS inflation breakeven rates have plummeted in the two years since QE3 was launched, dropping 50 basis points for a 5-year TIPS, 47 basis points for a 10-year TIPS and 43 basis points for a 30-year TIPS. Despite two years of Fed stimulus, inflation expectations are very low.
  2. The stock market, represented by the S&P 500, has had a great run, rising 36.6%.
  3. Despite that surge in wealth, inflation has been muted – rising just 2.9% overall in the 25 months of QE3.
  4. The yield on a 30-year Treasury has barely budged, rising just 9 basis points. Compare that with the yield of a 5-year TIPS, rising a whopping 167 basis points.

Conclusion. QE3 was expected to bolster TIPS, but that was a false premise back in 2012. Inflation didn’t rise, yet interest rates did eventually rise, and that caught TIPS investors in a bind: yields rising faster than the overall bond market.

On the other hand, today’s very low breakevens for TIPS across the maturity scale make them a much more attractive investment than they were in 2012. And those low breakevens give TIPS investors a ‘margin of safety’ …. because TIPS yields may now rise at a slower pace than the overall bond market, just the opposite of what happened in 2013.

I wouldn’t call TIPS a ‘buy’ in October 2014, but their appeal is rising.

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30-year TIPS reopening auctions with a yield of 0.985%

The Treasury just announced that the reopening of  CUSIP 912810RF7 – a 29-year 4-month Treasury Inflation-Protected Security – auctioned with a yield to maturity of 0.985%, a bit higher than looked likely this morning.

This TIPS – which first auctioned on Feb. 20 with a yield of 1.495% – carries a coupon rate of 1.375%, so today’s buyers are paying a premium. The adjusted cost is $112.17 per $100 of value, but this includes about 2% of accrued inflation since the original issue.

This is the first 29- to 30-year TIPS auction since February 2013 to come in with a yield under 1%.

Inflation breakeven rate. With a 30-year nominal Treasury currently yielding 3.05%, this TIPS has an inflation breakeven rate of 2.065%, making it very attractive against a traditional Treasury. It means that if inflation averages more than 2.065% over the next 30 years, this TIPS will outperform the nominal Treasury.

TIPS yields had been rising heading into the auction, and CUSIP 912810RF7 closed Wednesday with a yield of 0.922%. So today’s buyers gained from the market weakness (TIPS prices fall when yields rise). Here’s a look at the immediate reaction in the TIP ETF, which looks a bit negative:

TIP Oct. 23

Reaction to the auction

Despite the slight boost in expected yield, Bloomberg reports strong demand for this TIPS reopening, at least from foreign central banks, who are typically ‘indirect bidders':

Indirect bidders bought 64.5 percent of the $7 billion in Treasury Inflation Protected Securities yesterday, compared with the average of 46.7 percent at the past 10 auctions. … The transaction was rated a “four” by seven primary dealers, based on a scale of one through five, with one being a failed auction and five judging the results as outstanding.

The Wall Street Journal managed to write an entire article about weakness in the Treasury markets on Thursday without mentioning the TIPS auction. TIPS don’t get a lot of respect, I realize, but the WSJ did manage to give us this Thursday: ‘Janus Capital makes room for Bill Gross, his sunglasses‘:

Wall Street wants to know how Gross is doing at his new digs. So far, the feedback is hugely positive. Janus CEO Dick Weil described Gross as having, “a positive halo effect for the fixed-income team, but also for the whole firm.”

Well, good for Bill Gross and Janus. Until the next temper tantrum.

Posted in Investing in TIPS | 2 Comments

Quick check-in on today’s 30-year TIPS reopening

The US Treasury is reopening CUSIP 912810RF7 today, creating a 29-year 4-month Treasury Inflation-Protected Security with a coupon rate of of 1.375%. Non-competitive bids (such as through TreasuryDirect) need to be placed by noon, the auction closes for competitive bids at 1 p.m.

This TIPS – first issued in February – trades on the secondary market, so we can get a pretty good idea of today’s price. Here’s where we stand at 10:05 a.m.:

  • Bloomberg’s Current Yields page shows this TIPS trading right now with a yield of 0.94% and a price of about $111.10 per $100 of value. This is up about 5 basis points from when I wrote about this auction last week.
  • The Wall Street Journal’s Closing Prices chart shows this TIPS closed yesterday with a yield of 0.922% and a price of about $111.30.
  • The Treasury’s Real Yields estimate shows that a full-term 30-year TIPS closed yesterday at 0.94.
  • The TIP ETF is currently trading at $113.52, down about 0.25%, which indicates that yields are slightly rising.

So it looks like this TIPS might price with a yield of about 0.95% and somewhere around $111 per $100 of value, which results from the coupon rate of 1.375%.

This is down substantially from recent 30-year auctions, but much higher than the depths of yield we hit two years ago. I’ll post the auction results after 1 p.m. and provide more reaction later.

Meanwhile, you can study this … the results of every 29- to 30-year TIPS auction in history:

30 year TIPS

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September inflation rises 0.1%; new I Bond variable rate will be 1.48%

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1% in September on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, CPI-U (also called ‘headline’ inflation) was up 1.7%.

The September report provided the final piece of data needed to learn the new inflation-adjusted interest rate paid by US Savings I Bonds. The new variable rate – which goes into effect on Nov. 1 – is based on non-seasonally adjusted inflation from March to September 2014.

In March, the CPI-U index stood at 236.293, rising to 238.031 in September. This is a six-month inflation rate of 0.74%, so the new variable rate (annualized) will be 1.48%. I have updated my Tracking Inflation and I Bonds page to reflect these new numbers.

All I Bond holders will eventually get this variable rate for six months, but the date it begins will vary based on the month the I Bonds were issued. Potential I Bond investors can decide to buy before Nov. 1, however, and lock in the current 1.84% variable rate for the first six months, along with the current 0.1% fixed rate for the life of the I Bond.

We don’t know what the Treasury will decide on the fixed rate in November. I have speculated that it will either hold at 0.1% or drop to 0.0%. An increase looks highly unlikely.

In addition, September’s inflation report set the 2015 cost-of-living increase for 70 million Social Security recipients at 1.7%, the third year in a row the increase will be less than 2%.

The inflation report

The BLS reported strong declines in the price of gasoline (-1.0%) and fuel oil (-2.1%), but these declines were balanced off by increases in the costs of food (0.3%), medical care commodities (0.5%) and shelter (0.3%).

The September report again reflects very mild inflation, which has increased just 1.7% over the last 12 months. This is below the Federal Reserve’s target number of 2.0% and danger level of 2.5%, although the Fed uses a different index.

‘Core inflation,’ which strips out food and energy, also rose 0.1% in September and was up 1.7% over the last 12 months.

This chart shows how inflation has eased since the spring of 2014, essentially rising 0.0% over the last three months:

12 month

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I Bond watchers: Important inflation report coming Wednesday at 8:30 a.m.

The US Bureau of Labor Statistics will release the September inflation report Wednesday morning, and this is the final piece of data needed to determine the inflation-adjusted interest rate for US Savings I Bonds from Nov. 1, 2014, to April 30, 2015.

I record these inflation numbers on my Tracking Inflation and I Bonds page. The new I Bond inflation-adjusted rate will be determined by the May to September increase in the Consumer Price Index for All Urban Consumers, otherwise known as CPI-U or ‘headline inflation’ in the media. The one twist from the media reports, though, is that TIPS and I Bonds use non-seasonally-adjusted inflation as the measurement. The index stood at 236.293 in May 2014 and rose to 237.852 in August (although it has declined for two consecutive months).

If you look at my Tracking Inflation page, you can see that inflation from May to August rose 0.66%. If inflation came in at zero for September, the new I Bond variable rate would be set at 1.32% (annualized) for six months. So once we see the September number at 8:30 a.m. Wednesday, we’ll know the variable rate for the next six months.

I Bonds At a GlanceHowever … I Bonds are an odd investment because if you invest in I Bonds between now and Oct. 31, you will receive a fixed rate of 0.1% and a variable rate of 1.84% for six months and then you will receive the new variable rate for the next six months.

(Take a look at the chart to the right. It says I Bonds pay 1.94% through Oct. 31. That is the combination of the 0.1% fixed rate and the 1.84% variable rate, but if you buy before Nov. 1, you get that combo rate for the first six months. Get it?)

So if Wednesday’s inflation number comes in very low or negative, it might be smart to buy your 2014 allocation of I Bonds before Nov. 1 to lock in that higher variable interest rate for the first six months.

The other interesting thing about I Bonds is that the Treasury acts in total mystery when it sets the ‘fixed’ rate, which is currently 0.1% and never changes once you purchase the I Bond. We know nothing about the process the Treasury uses to determine this rate. However, my general guess is that the fixed rate tends to lag 70 to 100 basis points below the yield of a 10-year TIPS. See this chart.

A 10-year TIPS is yielding 0.28% today, so I would say there is a pretty good probability that the Treasury will lower the I Bond fixed rate to 0.0%, where it was from November 2010 to October 2013. But then again, the Treasury shocked everyone when it increased the fixed rate to 0.2% in November 2013, even with the 1o-year TIPS yield at just 0.40%. Six months later, the fixed rate dropped to 0.1% when the 10-year TIPS was yielding 0.49% … go figure.

My guess is that the Treasury either: 1) drops the fixed rate to 0.0% or 2) keeps it at 0.1% and there’s a near-zero chance of it increasing.

Purchase limits. I bought my 2014 allocation of I Bonds in February (and got the 0.2% fixed rate, which lasts the 30-year life of the I Bond). The Treasury allows individuals to buy $10,000 a year at, and an additional $5,000 in paper I Bonds issued as an income tax refund.

If you haven’t purchased your 2014 limit yet, you’ll have an interesting decision to make once the variable rate is set on Wednesday. Buy now or buy after Nov. 1? But you won’t know the new fixed rate until Nov. 1.

Posted in I Bond, Inflation, Savings Bond | 2 Comments

Up next: 30-year TIPS reopens at auction Oct. 23, 2014

Treasury logoThe US Treasury formally announced yesterday that it will reopen CUSIP 912810RF7 on Thursday, Oct. 23, creating a 29-year 4-month Treasury Inflation-Protected Security with a coupon rate of of 1.375%.

This TIPS initially auctioned on Feb. 20, 2014, with a yield to maturity of 1.495%. It reopened on June 19, 2014, with a yield of 1.116%, meaning buyers had to pay $108.34 for $100 of value to collect that coupon rate of 1.375%.

A lot has happened in the TIPS market in 2014. It’s been a roller-coaster ride, with the 30-year TIPS yield starting the year on Jan. 2 at 1.58% (the highest yield of 2014), declining to 0.98% on May 28, rising to 1.17% on June 10, falling to a 2014-low of 0.82% on Aug. 28, rising to 1.17% on Sept. 18, and closing yesterday at 0.89%.

What those numbers mean. CUSIP 912810RF7 is going to be expensive. Buyers at Thursday’s auction may be paying a nearly 13% premium to collect a coupon rate of 1.375%. In other words, $10,000 of this TIPS will cost a buyer $11,300. At maturity 29 years from now, the buyer will get back $10,000, plus inflation, while collecting $137.50 a year in interest (which will also rise with inflation).

This TIPS seems very risky as a trading vehicle, because an uptick in interest rates will send its market value plummeting. It only makes sense as a buy-and-hold investment, and a buyer is going to have to live 29 years, 4 months to get a return.

Let’s look at the current market for CUSIP 912810RF7:

  • Bloomberg’s Current Values chart shows it trading today at 0.89% with a price of about $112.40 per $100 of value.
  • The Wall Street Journal’s Closing Values chart shows that it ended Thursday with a yield of 0.865% and a price of about $112.72.
  • The Treasury’s Real Yields chart, which estimates the yield of a full-term 30-year TIPS, sets yesterday’s close at 0.89%

A lot can happen in a week, especially with the stock market showing plenty of volatility this month. But it’s not likely that this TIPS, which is currently trading just 7 basis points above its low for 2014, which get a lot cheaper before next Thursday.

One interesting factor in Oct. 2014, however, is the dramatic fall in inflation breakeven rates across all TIPS maturities. With a nominal 30-year Treasury yielding 2.94%, we’re looking at a 30-year inflation breakeven rate of just 2.05% – very low. That means this TIPS is actually a pretty good buy against a traditional Treasury.

30-year breakeven

What are the chances that inflation will average less than 2.05% over the next 30 years? It could happen, sure, but take a look at this chart of historical inflation ranges. Going back to 1961, the lowest 30-year inflation rate average was 2.8%, for the 30-year period ending in 2013.

Nevertheless, if I were in the market for a 30-year TIPS – which I am not – I probably would wait until the February 2015 auction of a new issue, when the yield and coupon rate will be aligned – lowering my upfront cost on a very long-term investment.

Posted in Investing in TIPS | 5 Comments

PenFed bumps up interest on longer-term CDs (finally)

In a Sept. 11 post, I noted the screwed up state of interest rates on super-safe investments. My evidence was an offering from the Pentagon Federal Credit Union of a 1-year insured  CD, paying 1.06% with just a $1,000 minimum investment.

Pretty good, but the problem was that PenFed’s 2- and 3-year CD rates dropped to 1.05% and the 5- and 7-year CDs were paying a measly 1.21%.

PenFedRidiculous, I noted. But now PenFed has attempted to repair that problem by upping its rates to more attractive levels, at least for 5- and 7-year CDs. These new rates are logical and competitive nationally.

According to, the national average for a 5-year CD is 1.87%, but you can find higher, such as:

  • 2.30% at Synchrony Bank
  • 2.53% at Chartway Federal Credit Union
  • 2.25% at Barclays
  • 2.25% at GE Capital Bank

My hometown credit union, Truliant, is paying just 1.40% for a 5-year CD with a minimal deposit. It shows how important it is to shop around when you have a CD maturing.

Posted in Investing in TIPS | 3 Comments