U.S. inflation fell 0.3% in November

The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.3% in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index – also called ‘headline inflation’ – increased 1.3%.

The BLS noted that the gasoline index – which fell a whopping 6.6% – posted its sharpest decline since December 2008 and was the main cause of November’s deflation. Food prices were up a moderate 0.2%, but apparel prices fell 1.1%. Medical care commodities were up 0.6%, and shelter costs were up 0.3%.

Holders of I Bonds and TIPS are also interested in non-seasonally adjusted inflation, which is used to adjust the principal balance of TIPS and set future interest rates for I Bonds. In November, the CPI-U index fell to 236.151, a drop of 0.54%. For the last 12 months, non-seasonally adjusted inflation rose 1.3%. I have updated my Tracking Inflation and I Bonds page to reflect these new numbers.

‘Core inflation’ – which strips out food and energy – rose 0.1% in November and 1.7% over the last 12 months. This demonstrates that even without the sharp decline in gasoline prices, inflation is running below the Federal Reserve’s implied target of 2.0%. Until inflation becomes a threat, the Fed has little reason to act quickly to raise short-term interest rates.

Here is a chart of the one-year trend for U.S. inflation, showing the sharply deflationary move since mid-2014:

One-year inflation

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Chart of the day: TIPS yield curve is flattening out

TIPS Yield Curve

Source: Bloomberg

My reaction: “Are my eyes deceiving me?”

A 5-year TIPS is trading on the secondary market with a yield to maturity of 0.31%, just 17 basis points below the yield on a 10-year TIPS, and only 54 basis points below a 30-year TIPS.

This is amazing – and the trend continues to make Thursday’s reopening of CUSIP 912828C99 the year’s most interesting TIPS auction. This is the same 5-year TIPS that is listed in the chart above, with an amazing yield of 0.31%.

One year ago – on Dec. 12, 2013 – TIPS were trading with drastically different yields, according to the Treasury’s Real Yields chart:

  • 5-year: -0.10%, 41 basis points lower than today.
  • 10-year: 0.75%, 27 basis points higher than today
  • 30-year: 1.63%, 78 basis points higher than today

Obviously, the market is pricing in extremely low inflation in the near term, causing the demand for short-term TIPS to plummet, and the yield to rise. The 5-year inflation breakeven rate is down to 1.26%, indicating the market believes inflation will run around that number for the next 4 years, 4 months – the remaining term on this TIPS.

If you think inflation will end up higher, this TIPS is a definite buy versus a nominal 5-year Treasury, which is currently yielding 1.57%.

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Up next: 5-year TIPS will reopen at auction Thursday, Dec. 18, 2014

Hey TIPS fans, we’re going to close out 2014 with a very interesting auction – one that might actually be worth an investment, especially if you are looking for a short-term TIPS with a positive yield, great inflation breakeven rate and a small discount on price.

The Treasury will announce later this morning (update: here is the announcement) that it will reopen CUSIP 912828C99 on Dec. 18, creating a 4-year, 4-month Treasury Inflation-Protected Security with a coupon rate of 0.125%. Here’s what we know about that issue:

  • It was first auctioned April 17, 2014 with a yield to maturity of -0.213%, requiring buyers to pay up to get the 0.125% coupon rate. The adjusted price was $101.87 for $100 of value.
  • It was reopened Aug. 21, 2014 with a yield to maturity of -0.281% and an adjusted price of $103.62 per $100 of value, which included about a 1.7% bump to principal because of inflation. (Hard to remember that inflation was running higher earlier in the year.)

This TIPS is a great example of odd developments in the Treasury market in 2014. Long-term TIPS yields have fallen, but shorter-term yields have risen. I think this has happened for a couple of reasons: 1) inflation looks to be very mild over the near future, with oil prices plummeting, and 2) the Federal Reserve keeps hinting that a rise in short-term interest rates is coming in 2015.

These numbers are from the Treasury’s Real Yields Chart for 2014:

  • A full-term 5-year TIPS was yielding 0.01% on Jan. 1 and yesterday closed at 0.31%, a rise of 30 basis points.
  • In that same time, yield on a 10-year TIPS fell 27 basis points, from 0.74% to 0.47%.
  • The yield on a 30-year TIPS fell a whopping 70 basis points, from 1.58% to 0.88%.

It’s surprising, because you’d think demand for shorter-term TIPS would be very high, given the threat of higher interest rates in the near future. But no, they are the best bargain in the TIPS world right now.

Next Thursday’s auction of CUSIP 912828C99 will create the shortest possible term (4-year, 4-months) you can get at a TIPS auction from the Treasury. And it might be sold at a small discount, in effect creating a zero-coupon note for the investor. You get a discount, collect a 0.125% coupon and then in April 2019 get back the par principal, plus inflation. What a deal.

Keep in mind, though, that this TIPS will carry about 1.5% in inflation adjustment to principal, which will wipe out the apparent discount. But you’ll get that money back in April 2019.

Here’s how CUSIP 912828C99 looks to be priced this morning:

  • Bloomberg’s Current Yields page shows it trading with a yield to maturity of 0.19%. Since that is above the coupon rate, it is priced at about $99.69 per $100 of value.
  • The Wall Street Journal’s Closing Prices page shows it closed yesterday with a yield of 0.158% and a price of about $99.62.
  • The Treasury’s Real Yields Curve page estimates a full-term 5-year TIPS would yield 0.31%. The Treasury has been flashing some very high yields for 5-year TIPS, as high as 0.43% on Dec. 8. I generally trust these numbers, but the volatility looks suspicious.

Inflation breakeven rate. Another oddity in the TIPS market is the sharply falling inflation breakeven rates. If we go with yesterday’s Treasury numbers, a 5-year TIPS is yielding 0.31% and a 5-year Treasury is yielding 1.58%. This sets up a shockingly low inflation breakeven rate of 1.27%. If inflation averages more than 1.27% over the next five years, this TIPS will outperform a traditional Treasury.

TIPS versus traditional Treasury? Seems like a no-brainer decision. Even if this TIPS ended up under-performing, investors would lose very little. Go with the inflation protection.

A lot can happen in a week, so if you are considering an investment in this TIPS, I’d suggest waiting until closer to the auction. I’ll be checking in on it next Thursday morning, and I’ll add a link to the formal announcement when it comes later today.

Meanwhile, consider that 12 consecutive 4- to 5-year TIPS auctions have resulted in a yield negative to inflation. This one could break the string, a welcome development!

5-year TIPS

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‘Real’ return: Why TIPS and I Bonds are still attractive

spare changeI was listening to NPR’s Marketplace last night, a story about the gentrification of a Los Angeles neighborhood. And then came this quote from Steve Jones, the owner of a house-flipping business, on how he attracts investors:

“All these people out there that have so much money, it’s sitting in a stupid money-market account making, you know, 2 percent or 3 percent, or whatever their horrible rates are right now …”

Steve Jones may know a lot about house-flipping, but he certainly knows nothing about investing in a money-market account. Fidelity’s main general-purpose money market account is yielding 0.01%, as is Vanguard’s Prime Money Market account. This has been true for more than six years. Vanguard’s fund has returned 0.04% annually over the last five years, and only 1.67% over the last 10 years.

So when someone calls 2% or 3% returns ‘horrible’ …. well, I would say those returns look pretty desirable, and almost impossible to find today in a super-safe investment.

A year ago, I wrote about a great 5-year CD offered by the Pentagon Federal Credit Union, paying 3.04%. It was offered only in December 2013 and January 2014; I speculated it was designed to draw new customers. It worked for me, and I jumped aboard.

I also have a set of 5-year CDs paying 3.0% from my local credit union, Truliant. These mature in various months of 2015. This was also part of a ‘special offer’ and well above market rates of 2010.

But, here we are in December 2014, and these are the rates being offered for Treasurys and non-jumbo CDs (the jumbos pay just slightly higher):

  • 0.01% Vanguard Prime Money Market
  • 0.14% 1-year Treasury
  • 0.26% National average 1-year CD
  • 0.30% Truliant 1-year CD
  • 0.80% Penfed 1-year CD
  • 0.84% National average 5-year CD
  • 1.00% Ally Bank 1-year CD
  • 1.20% Penfed 5-year CD
  • 1.40% Truliant 5-year CD
  • 1.69% 5-year Treasury
  • 2.32% Nationwide Bank 5-year CD

Just as a side note — it’s outrageous that a 5-year Treasury is out-yielding most 5-year bank CDs. There are no state income taxes on Treasurys, and these low rates indicate banks and credit unions are not making any attempt to sell 5-year CDs.

Now, let’s assume that inflation averages 2.0% over the next five years. My feeling is that this is a low number, but inflation has been very muted in recent years, so let’s go with 2.0%. Here are the ‘real’ returns – after inflation – for those investments:

  • - 1.99% Vanguard Prime Money Market
  • -1.86% 1-year Treasury
  • -1.74% National average 1-year CD
  • -1.70% Truliant 1-year CD
  • -1.20% Penfed 1-year CD
  • -1.16% National average 5-year CD
  • -1.00% Ally Bank 1-year CD
  • -0.80% Penfed 5-year CD
  • -0.60% Truliant 5-year CD
  • -0.31% 5 year-Treasury
  • 0.32% Nationwide Bank 5-year CD

Let’s compare this to I Bonds and TIPS. I Bonds purchased through April 30, 2015, will carry a fixed rate of 0.0%. This means they have a real return of 0.0% – and while that sounds bad, it makes I Bonds better than all the investment options on the above list, other than the Nationwide offering.

A five-year TIPS is currently yielding 0.21%. This translates to a real return of 0.21% – better than every investment on our list except for the Nationwide CD.

In addition, TIPS and I Bonds offer ‘inflation protection.’ If inflation rises to unexpected levels, the effective return on these investments also rises. You’re covered – and that is valuable insurance for investors.

A year ago, a 5-year TIPS was yielding -0.17%, 38 basis points lower than it is today. A 5-year Penfed CD was yielding 3.0%, 180 basis points higher than it is today. That is a massive swing – 218 basis points! – in favor of TIPS.

Last year, I argued that a 5-year CD was a better investment than a 5-year TIPS and at least competitive with I Bonds, which were then yielding 0.2% above inflation.

That’s no longer true as we approach 2015.

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10-year TIPS reopening auctions with a yield of 0.497%

The Treasury just announced that its reopening of CUSIP 912828WU0, creating a 9-year, 8-month Treasury Inflation-Protected Security, auctioned with a yield to maturity of 0.497% (plus inflation).

Because this TIPS carries a coupon rate of 0.125% – set at the original auction in July – today’s buyers got it at a discount – about $96.73 per $100 of value, figuring in a small amount of inflation appreciation since July.

Inflation breakeven rate. With the 10-year traditional Treasury trading today at 2.35%, this sets up an inflation breakeven rate of 1.853% for this TIPS. If inflation averages more than 1.85% over the next 10 years, it will outperform a traditional Treasury. This is a pretty attractive number – any breakeven rate below 2.0% for a 10-year TIPS indicates that TIPS are cheap against traditional Treasurys.

Here’s a chart of 10-year breakevens dating back to 2010:

10-year breakevenI’ll be updating this post later today with reaction to the auction, but the quick reaction in the TIP ETF after the auction closed at 1 p.m. seems to indicate it went well for the Treasury, with yields dropping this afternoon:


Reaction to the auction

The Wall Street Journal pointed out that this morning’s inflation report helped boost demand for this auction, because the flat number was slightly higher than expected:

The CPI report gave a boost to a $13 billion sale of 10-year Treasury inflation-protected securities on Thursday afternoon. The decent auction demand was a sign buyers deemed the recent selloff has turned the asset class into a bargain for inflation protection.

“The recent underperformance of TIPS seems to have started to attract some interest, especially given a better than expected CPI number,” said George Goncalves, head of U.S. interest rates strategy at Nomura Securities International in New York.

Bloomberg’s report noted strong demand for this auction, pointing out that the yield came in below 0.50% – hah!, which I had predicted:

“There was a lot of customer demand,” said Thomas Simons, a government-debt economist in New York at Jefferies LLC, one of the 22 primary dealers that are obligated to bid at Treasury sales. “All things considered, it was a bulls-eye.” … The notes were sold at a yield of 0.497 percent, compared with an average forecast of 0.504 percent in a survey of six primary dealers.

Reuters pointed out (in a paragraph that places way too much importance on 2 basis points) that 10-year breakevens rose after the auction as TIPS prices rose and yields declined (very slightly):

This gauge of investors’ long-term inflation expectations, as measured by the yield gap between 10-year TIPS and regular 10-year Treasury notes widened as much as 2 basis points to 1.86 percent after the 10-year TIPS auction.

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Checking in on today’s 10-year TIPS reopening

The Treasury today is reopening CUSIP 912828WU0 at auction, creating a 9-year, 8-month Treasury Inflation-Protected Security with a coupon rate of 0.125%. Here’s where this auction stands at 10:15 a.m.:

  • Bloomberg’s Current Yields page shows this TIPS trading on the secondary market with a yield of 0.490% and a price of about $96.59 per $100 of value. This discount is caused by the 0.125% coupon rate, which was locked in when this TIPS first auctioned in July.
  • The Wall Street Journal’s Closing Prices page shows this TIPS ended yesterday with a yield of 0.493% and a price of about $96.10.
  • The Treasury’s Real Yields Curve page shows a full-term 10-year TIPS would have yielded 0.53% at the close yesterday.
  • The TIP ETF is currently trading at $112.59, up 0.14%, which indicates that yields are slightly declining.

Put this together and you can estimate that today’s auction in going to result in a yield slightly under 0.50%, let’s say 0.49%. With the 10-year nominal Treasury trading today at 2.33%, you’re looking at an inflation breakeven rate of 1.84%. That’s very low, and in the buy range, at least versus a traditional Treasury. You could see a lot of interest in this issue from big-money central bands, hedge-funds, etc., and that would push the yield down.

The auction closes at noon for non-competitive bids (such as those placed at TreasuryDirect and at 1 p.m. for competitive bids. I’ll post again after 1 p.m. with the auction result.

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U.S. inflation was unchanged in October

The Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in October on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, inflation increased 1.7%.

This was slightly ‘higher’ than the expected number of -0.1%. October continued a string of months with sharply falling energy prices: Gasoline was down 3.0% in the month and fuel oil was down 4.0%. Also falling were prices for used cars and trucks (-0.9%) and apparel (-0.2%). These declines were balanced off by rises in the cost of shelter (0.2%), electricity (0.5%) and transportation services (0.8%). The food index rose 0.1% in October, its smallest increase since June.

Holders of I Bonds and TIPS are also interested in non-seasonally adjusted inflation, which is used to adjust the principal balance of TIPS and set future interest rates for I Bonds. In October, the CPI-U index number fell to 237.433, a drop of 0.25% from September’s 238.031. I have updated my Tracking Inflation and I Bonds page to reflect these new numbers.

Core inflation, which strips out food and energy, rose 0.2% in October and is up 1.8% over the last 12 months.

Here is the trend in CPI-U (also called ‘headline inflation’) over the last 12 months. Note that inflation has been essentially flat over the last four months:

chartWhile inflation remains very mild, October’s slightly higher-than-expected numbers could influence today’s reopening of a 10-year TIPS at auction. If investors see this as an uptick in inflation, it could cause higher demand. I’ll be checking in on this auction after the markets open and then again when it closes at 1 p.m.

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