Mid-year update: Where we stand with TIPS

It seems like the Treasury market has been on a wild ride in 2015, but in reality there’s been a lot of roiling around to get us back – pretty much – where we started the year. That is summed up by this chart, which shows the year-to-date performance of the TIP ETF:

2015 TIP ETFThe TIP ETF, which holds a broad range of maturities of Treasury Inflation-Protected Securities, started the year on Jan. 1 at $112.01 and closed Tuesday at $112.05, almost exactly flat. Add in some small distributions and you have a total return right around 1%; Yahoo Finance pegs it at 1.07%.

But as the chart shows, it has been a ‘wild’ ride – at least for a conservative Treasury investment – with the ETF hitting a year-to-date high of $115.63 on Jan. 30 before dipping to $111.51 on March 13, then rising again to $115.49 on April 17, then dipping again to a year-to-date low of $100.75 on June 10.

Keep this in mind: When the price of the ETF rises, TIPS yields are declining. When it drops, TIPS yields are rising. Buy-and-hold investors in TIPS want to see higher yields.

summaryThe chart at the right shows  highs and lows for the year for the three TIPS maturities available at auction. What’s interesting here is that yields have fallen on short-term TIPS while rising slightly for the 10-year and more sharply for the 30-year.

At the beginning of the year, there was only a 45-basis-point advantage in buying a 30-year TIPS versus a 5-year TIPS. That was ridiculously low. That spread has now grown to 109 basis points as 30-year yields rise to more reasonable levels.

The TIP ETF, by the way, isn’t very diversified, since there are only 39 TIPS currently trading on the secondary market. Of those, 16 have maturities of 5 years or less. Another 16 have maturities in the 5+ to 15-year range. That leaves only 7 with maturities above 15 years. So the ETF is more influenced by price swings in short-term TIPS, and its price was supported in 2015 as short-term yields fell, balancing off rises in longer-term yields.

When the TIP ETF bottomed out on June 10 at $100.75, the 10-year TIPS was yielding 0.63%. This trend, if it continues, could make TIPS investments interesting again. As yields approach 1% above inflation, the 10-year becomes attractive versus a US Savings I Bond, which currently pays 0.0% above inflation but has tax and maturity advantages.

(However, the I Bond’s fixed rate, which will be updated Nov. 1, tends to rise above 0.0% when the 10-year TIPS yields approaches 1.0%.)

Here is the long-term picture for 10-year TIPS yields. In this historical perspective, a yield of 1% above inflation looks pretty paltry. But it would be a big improvement over the last five years of ultra-depressed yields.

10-year yields

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30-year TIPS reopening auctions with a yield of 1.142%

The Treasury just announced that the reopening of CUSIP 912810RL4 – creating a 29-year, 8-month Treasury Inflation-Protected Security – auctioned with a real yield to maturity of 1.142%.

Since this TIPS was created in February with a coupon rate of 0.75%, buyers at today’s auction got it at a substantial discount – an adjusted price of $90.59 for about $100.47 of value. (This TIPS will have an inflation index of 1.00468 on the closing date of June 30.)

On the reverse side, buyers of this same TIPS back in February have seen its market value fall nearly 10% in only four months — an indication of how volatile long-term TIPS can be.

After the auction, the TIPS ETF took a slight bump up in price, indicating a mildly positive market reaction. It has been trading down all day, however.

Inflation breakeven rate. A 30-year nominal Treasury is trading today with a yield of 3.15%, setting up an inflation breakeven rate of 2.01% for this TIPS. That means if inflation averages higher than 2.01% over the next 30 years, this TIPS will outperform an nominal Treasury.

Back in February, this same TIPS auctioned with a breakeven rate of 1.89% — indicating that the market’s inflation expectations are rising. Here is a long-term chart of 30-year breakevens, showing that 2.0% remains on the low side of the scale:

30-year breakevens

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Checking in on today’s 30-year TIPS reopening auction

CUSIP 912810RL4 will reopen at auction today, creating a 29-year, 8-month Treasury Inflation-Protected Security. This TIPS has a coupon rate of 0.75%, which was set at the originating auction in February. Noncompetitive bids must be placed by noon; the auction closes at 1 p.m.

Here is how it is shaping up:

  • Bloomberg’ Current Yields page shows this TIPS trading today with a yield of 1.14%, about where it was a week ago, and with a price of $90.26 per $100 of value. It is going at a discount because the current yield is higher than the coupon rate of 0.75%.
  • The Wall Street Journal’s Closing Prices page shows this TIPS closed Wednesday with a yield of 1.051% and a price around $91.88.
  • The Treasury’s Real Yields Curve page estimated that a full-term 30-year TIPS would yield 1.09% at the close Wednesday.
  • The TIPS ETF – which holds a broad range of maturities – is trading at 10:30 a.m. at $112.01 this morning, down about 0.5% since Wednesday’s close. This indicates that TIPS yields are rising today, explaining the higher yield indicated by Bloomberg’s real-time quote.

So the market seems to be indicating a yield somewhere near 1.14% and an unadjusted price of about $90.26 per $100 of value. Because this TIPS will have an inflation index of 1.00468 on the June 30 closing date, the adjusted price will be a little higher.

Inflation breakeven rate. With the 30-year nominal Treasury currently yielding 3.13%, the inflation breakeven rate for this TIPS is right at 2% – still low but up from 1.73% in late January. It is low enough to make this TIPS attractive to big money buyers versus a nominal Treasury? Possibly.

Yes or no? I won’t be a buyer, but I am not high on adding 30-year TIPS into my buy-and-hold portfolio. I could (possibly) get interested if yields reach historically ‘normal’ levels of 2% or higher. But not today.

I’ll be posting an update after the auction closes at 1 p.m.

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U.S. inflation rises 0.4% in May on stronger gas prices

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4% in May on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, official inflation was unchanged — 0.0%.

The gasoline index increased sharply in May, rising 10.4% and accounting for most of overall increase. But gasoline prices are still down 25% over the last 12 months. Food prices were unchanged in May, the BLS said, and apparel prices were down 0.5%.

Core inflation – stripping out food and energy – was up 0.1% in May and 1.7% over the last 12 months. This indicates inflation has not yet reached a level (above 2.0%) that would prompt the Federal Reserve to begin raising short-term interest rates.

Holders of TIPS and I Bonds are also interested in non-seasonally adjusted inflation, which is used to determine principal adjustments on TIPS and future interest rates for I Bonds. May’s inflation index was set at 237.805, up 0.51% from April, but essentially unchanged from where it stood in May 2014 — 237.900.

I have updated my Tracking Inflation and I Bonds page to reflect these new numbers. It’s important to note that while I Bonds currently have a negative inflation-adjusted rate through Oct. 31 (-1.60% annualized) that number looks likely to rise into the positive when the new rate sets Nov. 1. Inflation is up 0.71% in the last two months.

top MayHere is the inflation trend over the last 12 months, showing that inflation is definitely rising after months of deflation in late 2014 and early 2015:

inflation

 

 

 

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Up next: 30-year TIPS reopens at auction on June 18, 2015

I am on the road this week and away from my computer, so I don’t have access to all my usual stuff. Oh well, I’ll try to provide a quick analysis of next Thursday’s auction — a reopening of CUSIP 912810RL4, creating a 29-year, 8-month Treasury Inflation-Protected Security.

This TIPS originally auctioned back in February, and at the time I questioned the sanity of anyone would would buy it. I quote myself from my auction previews (Feb. 12 and Feb. 19):

I also advise that a 30-year TIPS with a coupon rate of 0.75% can be a very dangerous investment if you can’t afford to hold it to maturity. If you are a TIPS buy-and-trader, you could be sitting on a time bomb. …

(This TIPS) doesn’t have much appeal for a small investor as a 30-year commitment, and it could be a very volatile issue for traders. (This TIPS will be reopened in June and October; if yields rise it could be a lot cheaper then.)

It auctioned on Feb. 19 with a coupon rate of 0.750% and a yield to maturity of 0.842%, generating the lowest yield for any 29- to 30-year TIPS auction since February 2013.

Tick, tick, tick …. This thing was bound to explode. In only four months, the market yield on a 30-year TIPS has risen from 0.842% to about 1.14% today. This TIPS has lost 10 percent of its value, and is currently trading with a price of about $90.09 per $100 of value.

  • The $90.09 price quoted above is from Bloomberg’ Current Yields page, which tracks real-time prices of TIPS on the secondary market. You can watch that page over the next week if you are interested in investing in this TIPS reopening.
  • The Wall Street Journal’s Closing Prices page shows this TIPS closing Thursday with a yield of 1.144% and a wide bid-to-ask spread – centered around $90 per $100.
  • The Treasury’s Real Yields Curve page estimates a full-term 30-year TIPS would yield 1.17% at the close Thursday, down from 1.25% from Wednesday.

This TIPS will carry an inflation index of 1.00468 on the June 30 closing date, which will slightly raise the price a TIPS will cost buyers.

For example, let’s say the yield comes in at 1.14% and the price is $90.09 per $100 of value. If you bought $10,000 of this TIPS, the inflation adjustment would raise your purchase to $10,046.80, but you would be buying at a discount ($90.09 per $100) so your total cost would come to around $9,051 for $10,000 par.

Still, even with the discount, I can’t see this TIPS being a slam-dunk purchase. An after-inflation yield of 1.14% is still very low by historical standards for a 30-year TIPS. But it’s certainly a lot more attractive than the February auction’s 0.842%.

Note: If held in a taxable account, the 0.75% coupon rate on this TIPS will make it just barely cash-flow positive over nearly 30 years. You will owe taxes in the current year for inflation adjustments to principal, but you won’t get that money until you sell the TIPS or it matures. Keep that in mind.

Here is a history of all 29- to 30-year TIPS auction. I’ll be posting next week before and after the auction:

30-year TIPS

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I Bond confusion: Understanding how the 0.0% rate rolls out

Back on May 1, I wrote an article about how the new  I Bond inflation adjusted variable rate had fallen into the deep negative, -1.60% (annualized). And this meant any Series I Savings Bond with a fixed rate of  1.6% or less would pay 0.0% for six months.

Since then several readers have commented that they aren’t seeing the 0.0% rate in the Savings Bond Wizard. Others have cursed me and told me I have it all wrong, believing that the fixed rate is ‘fixed’ and can never be reduced. Others are just confused.

If you use the Treasury’s Savings Bond Wizard, you are going to see some misleading numbers for awhile, but they aren’t wrong. (I love the Wizard, by the way, it is an excellent tool.) If you have it, open it up today and get the latest update, which provides interest rates through November 2015.

But first, read this …

How is that rate calculated? The Treasury Direct site has a lot of great information on I Bonds, including a very good Rates & Terms page. This chart showing the I Bond rate formula is drawn from that page:

I Bond formulaOK, it’s obvious if the fixed rate is 0.0% and the inflation rate is negative, the composite rate is going to drop to 0.0%, the lowest possible. But what if your fixed rate is 3.0%, as it was back in the good old days (May to November 2001)? What will happen to your fixed rate under that formula? Here is the calculation:

[0.0300 + (2 x -0.0080) + (0.0300 x -0.0080)]
[0.0300 + -0.0160 + – 0.00024]
0.01376
resulting in a composite rate of 1.38%

So, according to the Treasury formula, your fixed rate will be lowered by the negative inflation rate. It will result in a composite rate of 1.38% for six months.

But … my Savings Bond Wizard shows a higher rate! It might, and it isn’t wrong. The I Bond composite rate rolls out across six months, depending on the month when you first bought the I Bond. The Treasury has another nice chart that shows this:

I Bond rate rolloutSo the Savings Bond Wizard will continue to show a higher rate, based on the last period’s 1.48% variable rate, until the new rate kicks in – depending on the month when you first bought the I Bond. If you bought an I Bond in October 2003, the new rate will begin in October 2015 and continue for six months. If you bought in November 2003, the new rate started May 1 and will continue for six months.

I have updated my Savings Bond Wizard and here is what is it showing for May 2015 and November 2015 for the I Bonds I currently own:

May November

FYI: Rate is the current six-month composite rate, yield is the annualized yield over the lifetime of the I Bond.

That is almost crystal clear, isn’t it? As the new composite rate rolls out over the next six months, all my I Bonds will be affected by the -1.6% variable rate, and the yield – the annualized interest paid over the life of the I Bond – will also decline.

Take a look at the two I Bonds issued in October 2001. They have a fixed rate of 3.0% (nice!) and so they fit the formula that I posted above:

[0.0300 + (2 x -0.0080) + (0.0300 x -0.0080)]
[0.0300 + -0.0160 + – 0.00024]
0.01376
resulting in a composite rate of 1.38%

If you look at the November 2015 rate, it is 1.38%.

And another thing. I am totally, 100% recommending hanging on to all your I Bonds through this six months of reduced returns. Inflation fell at an annual rate of -1.60% from September 2014 to March 2015. Even if you are getting a return of 0.0%, you are beating inflation by 1.6%. You’ll survive.

Because you can buy only $10,000 per person in I Bonds each calendar year (plus the IRS refund trick), they are an asset to hold. I Bonds are part of a strategy of pushing inflation-protected, tax-deferred money into the future. The only reason to sell them is if you need the cash right now.

I hope this helps clear up some of the confusion circling around I Bonds in these strange months of post-deflation 2015.

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U.S. inflation remains muted, increasing 0.1% in April

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

Falling energy prices were a key factor in April’s mild inflation. Gasoline prices, for example, fell -1.7% after rising in the two previous months. Gas prices are down -31.7% over the last 12 months. Fuel oil prices were down a very strong -8.4% in April, the BLS reported. Balancing off those declines were increases in medical care services (0.9%), shelter (0.3%) and used cars and trucks (0.6%). Overall food prices were unchanged in April.

Core inflation – which strips out energy and food – was up 0.3%, its largest increase since January 2013. Core inflation is up 1.8% over the last 12 months.

Holders of TIPS and I Bonds are also interested in non-seasonally adjusted inflation, which is used to determine the principal adjustments for TIPS and future interest rates for I Bonds. In April, the inflation index rose 0.2% to 236.599, but over the last 12 months inflation was negative at -0.2%.

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

Although overall inflation remains very muted, April’s core inflation number could give the Federal Reserve something to ponder. The Fed adopted a 2% inflation target in April 2012. Core inflation of 1.8% is approaching that number, but I still can’t see the Fed acting to raise short-term interest rates in the near term.

Here is the inflation trend for the last 12 months:

inflation trend

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