5-year TIPS auctions with a real yield of -0.335%

A new five-year Treasury Inflation-Protected Security – CUSIP 912828K33 – auctioned today with a real yield (after inflation) to maturity of -0.335%. The coupon rate was set at 0.125%, the lowest the Treasury allows on a TIPS.

This is the lowest yield for any 4- to 5-year TIPS at auction since Dec. 19, 2013, when a 4-year, 4-month TIPS auctioned with a yield of -0.375%. Because the yield ended up well below the coupon rate, buyers at today’s auction had to pay about $102.52 for $100 of value.

Inflation breakeven rate. With a nominal 5-year Treasury currently trading at about 1.41%, this sets up an inflation breakeven rate of 1.74% for this TIPS. That means if inflation averages higher than 1.74% over the next five years, this TIPS will outperform a nominal Treasury. Although this number is low by historic standards, inflation has been running at -0.1% over the last 12 months.

This chart shows the 5-year inflation breakeven rate since 2010, and shows that the 5-year TIPS have bounced off very low levels in recent months. The lower the breakeven rate, the ‘cheaper’ TIPS are against a nominal Treasury. It’s clear that TIPS are getting more expensive, and that indicates that inflationary fears are rising:

5-year breakeven rates

Reaction to the auction

We can get a quick read on reaction to the auction by looking at how the TIP ETF performed in the minutes after the 1 p.m. auction close. The ETF had been trading up slightly all morning, and took a minor move downward after the closing, indicating a trend of higher yields. This isn’t a significant move, however.

auction reaction

Bloomberg’s report on the auction noted that investors are again beginning to factor inflation into their investments:

“The market likes TIPS,” said Edward Acton, a U.S. government-bond strategist in Stamford, Connecticut, for Royal Bank of Scotland’s RBS Securities unit, one of 22 primary dealers obligated to bid at U.S. auctions. “This disinflationary pressure has eased off, and we’re just waiting to see how strong and how quickly inflation pressures can surprise to the upside.” …

Pacific Investment Management Co., which runs the world’s biggest bond fund, has been among the buyers of TIPS.

“With the oil price drop, we felt that break-evens in the Treasury Inflation-Protected Securities market were pricing in inflation that was too low,” New York-based portfolio manager David Braun said in a note published online Thursday. “So we prefer to own TIPS in lieu of nominal Treasuries.”

The Wall Street Journal also noted the gentle rise in inflation as a source for demand for TIPS, noting that “investors are piling into U.S. government bonds that protect against inflation at the fastest pace in three years.”

“The big picture is that the deflation scare may be behind us,’’ said Gemma Wright-Casparius, senior bond-fund manager at Vanguard Group, which has over $3.26 trillion in global assets under management. “The overall sentiment will be inflation moving higher over the next 12 months.”

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Checking in on today’s 5-year TIPS auction

A new 5-year Treasury Inflation-Protected Security – CUSIP 912828K33 – will be created today, with the coupon rate and real yield to maturity determined at auction. Non-competitive bids, like those placed through Treasury Direct, close at noon; competitive bids continue until 1 p.m. when the auction closes.

At 10:07 a.m., here is what we know:

  • The coupon rate is going to be 0.125%, because this TIPS will auction with a negative yield to maturity, and 0.125% is the lowest coupon rate the Treasury allows.
  • After yesterday’s close, the Treasury’s Real Yield Curve page estimated that a full-term 5-year TIPS would yield -0.19%. This should be the starting point for today’s auction, since the most recent 5-year TIPS on the secondary market has only four years remaining.
  • That said, Bloomberg’s Current Yields page shows that 4-year TIPS trading today with a real yield to maturity of -0.51%. That’s substantially below the Treasury’s estimate.
  • The Wall Street Journal’s TIPS Closing Yields page shows that 4-year TIPS, which matures in April 2019, closed yesterday with a yield of -0.470%. There is also a TIPS maturing in July 2020 with a yield of -0.448%, and one maturing in January 2020 with a yield of -0.428%.
  • Finally, the TIP ETF – which holds a broad range of maturities – is trading up very slightly this morning at $114.41, indicating that yields could be dipping, but only slightly.

These numbers would lead me to guess that today’s auction will result in a yield below -0.20%. Will the number be closer to -0.45% or even -0.50%? Seems possible. That’s a pretty wide span of probabilities; I would guess a yield near -0.45% looks likely.

Since the coupon rate will be set at 0.125% on this new issue, buyers at today’s auction will have to pay up to generate a negative yield to maturity. If the yield comes in around -0.21%, the price will be about $101.85 per $100 of value. If it falls to -0.50%, the price will be closer to $103 per $100 of value, as a rough guideline.

I will be posting an update after the auction closes at 1 p.m., and then adding market reaction later in the afternoon.

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Variable interest rate on I Bonds will drop to -1.60% on May 1

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in March on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index declined 0.1%.

This is an important inflation report, because it provides the last number needed to determine the new variable interest rate for Series I Savings Bonds, which will reset on May 1. Because non-seasonally adjusted inflation dropped 0.8% from September 2014 to March 2015, the new I Bond variable rate will fall to -1.60% annualized on May 1. That variable rate will be applied against any fixed rate that I Bonds hold, meaning that all I Bonds issued in the last 13 years will pay zero interest for six months beginning on May 1. (But the trigger date for the 0.0% period will depend on the month you first bought the I Bond, a tricky I Bond feature.)

I have updated my Tracking Inflation and I Bonds page to reflect these updated numbers.

The inflation report. An increase of 0.2% in March was expected, so no surprise there. Energy prices rose again in March, with gasoline prices rising 3.8% after a 2.1% rise in February. Fuel oil prices were up a strong 5.9%. On the other hand, natural gas prices dropped 2.7% and food prices fell. 0.2%.

Holders of I Bonds and Treasury Inflation-Protected Securities are also interested in the non-seasonally adjusted CPI-U, which is used to determine the future variable interest rate on I Bonds and to adjust the principal balance of TIPS. In March, non-seasonally adjusted CPI rose 0.6% to an index level of 236.119. That number stood at 238.031 in September, meaning non-seasonally adjusted inflation fell 0.80% from September to March. This number determines the I Bond’s new variable rate of -1.60% annualized for the six months from May to October.

six months

What this means for I Bonds.  Since the variable rate is added to the fixed rate to determine the I Bond’s composite rate, this means that the -1.6% will wipe out any fixed rate of 1.6% or lower. And that means those I Bonds will have a composite rate of 0.0% for the six months beginning in May, since the I Bond rate can’t fall below zero.

We don’t yet know what fixed rate the Treasury will apply on May 1, but the most likely number is 0.0%, where the fixed rate stands today. As a rough guide – not always accurate – the I Bond fixed rate usually falls about 1% below the yield of a 10-year TIPS. Right now a 10-year TIPS is yielding 0.05% – so unless the Treasury is feeling unusually generous, the I Bond’s fixed rate will hold at 0.0% on May 1.

Should you buy I Bonds this year? If the fixed rate stays at 0.0% on May 1, we can assume the market for new purchases of I Bonds will dry up. There’s not much sense in guaranteeing a 0.0% return, since you can wait for the rate reset on Nov. 1 and buy your 2015 allocation then. (I Bond purchases are limited to $10,000 per person per year.)

If the fixed rate rises above 0.0% – unlikely – then I Bonds again are attractive because the fixed rate stays with the I Bond for 30 years. You won’t get rich getting an extra 0.1% over inflation, but every little bit helps.

Or you can buy your annual allocation before May 1 and get six months of 1.48% annualized, followed by 0.0% annualized, for a combined rate of 0.74% for one year. Why bother?

The most logical action will be to keep your cash earning money somewhere until Nov. 1, and then deciding if the I Bond composite rate looks attractive. On Nov. 1, you could also take a long look at Series EE Savings Bonds, which currently pay 0.1% annual interest but will double in value if held for 20 years, for an effective rate of 3.5%.

(Another option: Buy the EE Bonds before May 1, to head off any possible change in Treasury policy. What if the Treasury extends the EE doubling to 25 years? Or 30 years? It could happen, since a 20-year Treasury currently pays 2.31%, well below the EE’s return.)

Here is the trend in inflation over the last 12 months:

Inflation

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Up next: New 5-year TIPS will auction April 23, 2015

The Treasury will announce later this morning that it will be offering a new 5-year Treasury Inflation-Protected Security at auction on Thursday, April 23. This will be CUSIP 912828K33. Update: Here is the announcement.

The market for 4- to 5-year TIPS has changed dramatically since the Treasury’s last auction of this term, on Dec. 18, 2014, when a a 4-year, 4-month TIPS auctioned with a yield of 0.395%, highest in 4 1/2 years.

Today we are looking at a yield in the range of -0.26%, a decline of 65 basis points since December. But that’s still well above the record low of -1.496% for the auction of a 4-year, 4-month TIPS on Dec. 20, 2012.

Because the lowest-possible coupon rate for this TIPS is 0.125%, buyers will likely be paying up at next Thursday’s auction, somewhere around $101.92 for $100 of value to produce a yield to maturity of -0.26%. (A lot can change in a week, of course.)

Inflation breakeven rate. With the 5-year Treasury currently yielding about 1.33%, this sets up an inflation breakeven rate of 1.59% for this TIPS, meaning that it will outperform a 5-year nominal Treasury if inflation averages more than 1.59% over the next 5 years. Inflation has been running at 0.0% over the last 12 months.

Alternatives. The 5-year term sets up good comparisons with other ultra-safe investments. For example, you can buy an I Bond today and be assured that you will earn at least the inflation rate over the next five years. That return will be 0.26% better than the return of this TIPS, and so an I Bond – as weak as it seems right now – is a better investment.

Another alternative is 5-year insured bank CDs, which pay 2.00% to 2.25% right now at several banks. The 2.25% return sets up an inflation breakeven rate of 2.51% for this TIPS. If you don’t believe inflation will average higher than 2.51% over the next 5 years, the bank CD is a better investment.

Why buy it? I like the 5-year term, and I was a buyer last December when the yield hit a favorable 0.395%. But next Thursday’s auction will be interesting mainly to big-money investors like central banks, pension funds and hedge funds — where small-dollar alternatives make no sense. I suspect many small investors will pass and look for better alternatives.

Here is the history of all 4- to 5-year TIPS auctions since 2007:

5 year TIPS

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Here we go again: TIPS yields are diving toward the negative

BunnyI hate to be negative, but the current trend in the Treasury market has me thinking evil thoughts. Why? Yields on Treasury Inflation-Protected Securities have dropped to levels negative to inflation for maturities all the way up to 9 years. There are 39 TIPS currently trading on the secondary market, and yields are negative on 23 of them.

This is great if you own TIPS you want to trade or if you are invested in TIPS mutual funds. The value of your holdings has ‘soared’ – as much as Treasurys ever soar – in the brief time since Valentine’s Day. Here’s a chart for that time, comparing the TIP ETF, which holds the full range of TIPS, with the SPY ETF, invested in the S&P 500.

TIP vs. SPY

Click on image for larger version

My evil thoughts arise because I’d like to be a net buyer of TIPS, buying more than mature each year as part of a super-safe allocation in my heading-to-retirement portfolio. But right now TIPS are off the table, and I’d certainly shy away from TIPS mutual funds. And I Bonds – another trusty, super-safe investment – are about to enter a six-month period paying zero interest. Bank CDs – paying about 1% for a 1-year CD and 2.25% for a 5-year – might be a more acceptable alternative, although hardly desirable.

I’ve called TIPS the ‘Energizer Bunny’ investment in the past – they just keep going and going. Look at a 5-year TIPS. Last year’s December reopening auction resulted in a yield of 0.395%, highest in 4 1/2 years. Today, the yield on that same TIPS is -0.505%, down a shocking 90 basis points in five months. And yet the inflation index for that TIPS is .997; there has been less-than-zero inflation since this TIPS was first issued in April 2014.

Here are factors driving TIPS yields down:

  1. Central banks around the world are trying to inflate their currencies with asset-buying programs, resulting in 10-year bonds in Switzerland paying -0.11%; in Germany, 0.17%; in the Netherlands, 0.33%; in more-risky Portugal, 1.68%. You can get 1.88% in the non-risky United States, and that is where money is flowing.
  2. A crucial turning point came March 18, when Federal Reserve Chair Janet Yellen gave a decidedly wish-washy view on future short-term interest rate increases in the United States. She said: “Just because we removed the word ‘patient’ doesn’t mean we’re going to be impatient” in raising rates. The market interpreted this – correctly, I think – that the Federal Reserve lacks the courage to begin raising interest rates until inflation is above – possibly well above – its target of 2%.
  3. Yellen’s comments weakened the dollar, with the Euro gaining about 3% in value since her statement. It also ignited just a touch of inflation fears, which had been dormant after months of mild deflation. This makes TIPS more appealing, even at these low yields.
  4. If you suspect inflation will rise again to around 2%, TIPS are still the relative ‘bargain’ of the Treasury market. A 10-year TIPS currently has an inflation breakeven rate of about 1.81%. This number usually averages in the 2.0% to 2.2% range, so TIPS remain cheap against nominal Treasurys. That also increases demand.

Just as a rough guideline, I often say that TIPS mutual funds would be appealing to me when the TIP ETF reaches $110. This would happen when the 10-year yield rises to about 0.90%, a long way up from the current 0.07%.

But consider this: The TIP ETF closed at $111.51 on March 13, less than one month ago. Since then it is up 2.7%, and the Energizer Bunny dances on.

Posted in Investing in TIPS | 11 Comments

Deflation breaks (slightly), as US inflation rises 0.2% in February

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in February on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, US inflation was flat – 0.0%.

February’s slight increase was expected, because gasoline prices rose 2.4% in the month, after falling 18.7% in January. Overall, the energy index rose 1.0%. Food prices were up a moderate 0.2%. But prices for used cars and trucks were up a sharp 1.0% and medical care commodities rose 0.7%. Apparel was up 0.3%.

‘Core inflation,’ which strips out food and energy, was also up 0.2% in February and has risen 1.7% over the last 12 months.

Holders of Treasury Inflation-Protected Securities and I Bonds are also interested in the non-seasonally adjusted CPI-U, which determines the inflation adjustment to TIPS principal and the future interest rate paid on I Bonds. In February, the inflation index stood at 234.722, up 0.43% over January’s number. But inflation was almost exactly flat over the last 12 months; the February 2014 number stood at 234.781.

Today’s numbers mean holders of TIPS will see gradual increases in principal in April, after several months of deflationary declines. Holders of I Bonds are almost certainly going to see six months of zero interest at the next adjustment on May 1. That adjustment will be based on inflation from September to March 2015, which is currently running at -1.39% with only one month to go. A large negative number will also wipe out any fixed rate the I Bond pays – up to that number – but an I Bond’s principal never declines and its interest rate can never go below zero.

I have updated my Tracking Inflation and I Bonds page to reflect these new numbers. See also my previous posts: TIPS versus I Bonds during deflationary times and Deflation strikes hard in January: What does it mean for TIPS and I Bonds? .

I’d suspect that today’s inflation number will have little effect on the Federal Reserve’s decision to raise short-term interest rates later this year. Oil prices have been declining recently, which should lead to stable gasoline prices as we head into summer.

Here is the 12-month trend in seasonally adjusted CPI-U:

Year of Zero Inflation

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10-year TIPS reopens with a real yield of 0.2%, nearly a 2-year low

The Treasury just announced that its reopening auction of CUSIP 912828H45 auctioned with a real yield (after inflation) to maturity of 0.2%, the lowest yield for an 9- to 10-year TIPS at auction since May 2013.

This Treasury Inflation-Protected Security has a coupon rate of 0.25%, so that means buyers at today’s auction had to ‘pay up’ slightly to get that coupon rate. However, because this TIPS has an inflation index of 0.98686, the adjusted price worked out to $99.16 per $98.68 of value, but par is guaranteed to rise to at least $100 at maturity.

Today’s yield was much lower than looked likely just two days ago, when this TIPS closed on the secondary market with a yield of 0.425%. The dramatic dip in yields came after the Federal Reserve announced it would be cautious in raising short-term interest rates this year. That move boosted the TIPS market because 1) short-term interest rates will remain very low for the near term and 2) the Fed indicated – once again – that it is willing to risk rising inflation if it results in job creation and rising wages.

Inflation breakeven rate. A nominal 10-year Treasury is trading right now at 1.97%, creating an inflation breakeven rate of 1.77%, about 5 basis points higher than the breakeven rate of a week ago, but still solidly in the ‘cheap’ range, indicating this TIPS is attractive versus a traditional Treasury.

Reaction to the auction. The TIP ETF, which holds a broad range of maturities, was trading down most of the day, but after the auction closed at 1 p.m., its price moved upward, indicating declining yields and a positive reaction to the auction.

TIP ETF

Bloomberg’s report on the auction noted the effect the Federal Reserve’s cautious statement had on the TIPS market:

The U.S. Treasury Department can thank the Federal Reserve for the surge in demand at Thursday’s auction of inflation-protected bonds.  … “The Fed backing away from its harsh stance frees inflation expectations to rise a little bit more,” said Jim Vogel, head of interest-rate strategy at FTN Financial in Memphis, Tennessee.

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