5-year TIPS auctions with a yield of -0.213%

The Treasury just announced that a new 5-year TIPS, CUSIP 912828C99, auctioned with a yield to maturity of -0.213% and a coupon rate of 01.25%. The combination of negative yield and positive coupon rate means that buyers paid an adjusted price of $101.87 for $100 of value, which includes about 5 cents of inflation adjustment through April 30.

Read the announcement.

The yield of -0.213% continued a string of 11 consecutive 4- to 5-year TIPS auctions that produced a yield negative to inflation. Because the principal balance of a TIPS grows with inflation, buyers today accepted a return 0.123% less than inflation over the next five years.

When you look at the 5-year inflation breakeven rate, you can see why some buyers would find this issue attractive. A 5-year nominal Treasury is trading right now at 1.70%,  setting up an inflation breakeven rate of 1.91%, meaning that this TIPS will outperform a traditional Treasury if inflation averages more than 1.91% over five years.

Even if this 5-year TIPS under-performs, it probably won’t be by much, so TIPS buyers aren’t giving up much yield to get the inflation protection.

TIP ETFTwo weeks ago, this TIPS looked likely to carry a positive yield, but Treasurys  strengthened as the stock market weakened and turmoil rose again in Ukraine. The TIP ETF was up strongly in the minutes after the auction closed, indicating a positive reaction to the auction.

At 11:14 a.m., before the auction closed, Bloomberg forecast a yield of -01.62%, based on a survey of primary dealers.

So it looks like the Treasury is the winner in today’s auction.

Reaction to the auction

The Wall Street Journal’s Cynthia Lin noted ‘a strong turnout’ for this auction, noting that the yield of 0.213% was less than the market rate at the time of the sale,  “reflecting strong demand.”

Bloomberg’s Cordell Eddings noted strong demand from overseas buyers, which include central banks.

The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.7, matching the highest level since December 2012. “The stats were off the charts,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., a primary dealer.



Posted in Investing in TIPS | 1 Comment

Checking in on today’s 5-year TIPS auction — note earlier bid times

The U.S. Treasury will announce results of its auction of a new 5-year Treasury Inflation-Protected Security, CUSIP 912828C99, just after 11:30 a.m. Non-competitive bids have to be placed by 11 a.m., if you are buying at TreasuryDirect. The times are earlier for this auction because of the Easter weekend.

What to expect. This TIPS has been a hard one to call, with possible yields falling all over the place. A few weeks ago, it looked like this TIPS would generate a positive yield to maturity (plus inflation), but that looks unlikely now. The coupon rate will almost certainly be 0.125%, the same rate for the last nine 4-to 5-year TIPS auctions, because that is the lowest coupon rate the Treasury allows on TIPS.

Combine a negative yield at auction with a coupon rate of 0.125% and you get an above-par price for buyers at today’s auction, possibly $102 or more for $100 of value.

  • The Treasury’s chart of Daily Treasury Real Yield Curve Rates is currently showing a 5-year TIPS yielding -0.06%. This is usually my preferred source for new issues, but the number looks a little suspect because …
  • Bloomberg’s Current Yields chart this morning is showing a yield of -0.50% for the newest 5-year TIPS currently trading. But this TIPS was issued a year ago, so it is actually a 4-year TIPS and that skews the number. You’d expect a shorter-maturity TIPS to yield less, especially in a time of very low inflation.
  • The Wall Street Journal’s closing prices chart shows TIPS bracketing the maturity date of this new TIPS yielding -0.401% and -0.365%, and you have to go out to a maturity of July 2020 to find a yield of -0.118%

So, at this point, the Treasury seems to be predicting one number (-0.06%) and the market points to another (maybe around -0.385%). That’s a 32-basis point swing – an unusual amount of uncertainty.

The 5-year nominal Treasury closed Wednesday at 1.67%, setting up a 5-year inflation breakeven point of 1.73% (if you trust Treasury’s low prediction) or 2.05% (if you trust the market numbers).

If this TIPS goes off with a yield of -0.06%, it will be a pretty good bargain for buyers. We’ll see what happens at 11:30 a.m.

Posted in Investing in TIPS | 2 Comments

U.S. inflation rose 0.2% in March, what does this mean for I Bonds?

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 this morning. This was slightly higher than the expected rate of 0.1%, and resulted in an inflation rate of 1.5% over the last 12 months.

Increases in the shelter and food indexes accounted for most of the increase. The food index increased 0.4% in March, with several major grocery. The energy index, in contrast, declined slightly in March, with gasoline down 1.7% and fuel oil down 2.9%. Utility gas service was up a strong 7.5%.

Excluding the volatile food and energy categories, core prices increased 0.2& in March and 1.7% in the past year.

Holders of TIPS and I Bonds are also interested in the non-seasonally adjusted CPI-U, which is used to determine the inflation adjustment on TIPS and the future inflation-adjusted interest rate on I Bonds. This number was up 0.6% in March, but the number for the last 12 months remains at 1.5%.

What this means for I Bonds. The March inflation number was the last piece needed to determine the inflation-adjusted variable rate for I Bonds that will begin May 1.

The inflation index at the end of March was 236.293, a 0.9156% increase over the 234.149 recorded at the end of September 2013. This should mean that the new I Bond inflation-adjusted rate will go to an annual rate of 1.83% or 1.84% for six months beginning May 1.

The annualized rate is currently 1.18%, plus a fixed rate of 0.2% that lasts as long as you hold the I Bond. We don’t know if the Treasury on May 1 will keep the fixed rate at 0.2%, drop it, or raise it. The Treasury does not provide a formula on how it makes this decision.

I’ll be checking this morning for confirmation on my calculations. Check back for more details.

Posted in I Bond, Inflation, Investing in TIPS | Leave a comment

Next up: 5-year TIPS auctions April 17, 2014

What was looking like a fairly attractive auction of a new 5-year Treasury Inflation-Protected Security has lost a little of its luster in the last week, but this one is still worth a look. The Treasury announced Thursday it will auction CUSIP 912828C99 on April 17, 2014, with the coupon rate and yield to maturity to be set at auction.

What can we expect? The coupon rate will almost certainly be 0.125%, the same rate for the last nine 4-to 5-year TIPS auctions. That streak was set because 4- to 5-year TIPS have been yielding negative to inflation almost every day since late September 2010. The lowest coupon rate the Treasury will set on a TIPS is 0.125%, and that means buyers have to ‘pay up’ when an auction results in a negative yield.

According to the Treasury’s Daily Yield Curve tables, a 5-year TIPS is currently yielding -0.10%, down from year-to-date high of 0.11% set on April 3. So the yield has dropped 21 basis points in a eight days – not a good trend heading into an auction.

Why the drop in yield? This one is a ‘flight to safety’ — Treasurys always benefit when the stock market is in turmoil. A nominal 5-year Treasury is yielding 1.59%, down 21 basis points in nine days. During that same time, the S&P 500 stock index is down 3.03%.

Stocks versus TIPSWhy is the stock market weakening? Could it be that it has had a remarkable run-up for more than five years and some high-risk stocks were getting very bubbly? Could be, but I have no idea what drives the stock market and if this trend will continue.

If it does continue, though, we can forecast that we are in for a short-term decline in TIPS yields heading into next Thursday’s auction.

Looking for yield. At the beginning of April, it looked like we would get a 5-year TIPS auction with a positive yield, and that would have been worth a celebration. It’s been four years since we’ve seen that. At the least, it would have meant buyers would get a 5-year TIPS at around par. That doesn’t look likely now. Buyers can expect to pay $101.50 to 102.00, at least, for $100 of value at next week’s auction.

And it isn’t a good thing that a TIPS maturing 2019 Jul 15 is currently trading at -0.387%.

If this TIPS does go off at -0.10%, it would be the highest yield for any 4- to 5-year TIPS in four years, since an April 2010 auction netted a yield of 0.55%. But it looks more likely that the recent high of -0.127%, set in August 2013, will hold until the next reissue. I was a buyer at that auction, but I will probably pass on this one.

Here are the numbers for recent 4- to 5-year TIPS auctions:

5 year TIPSThe I Bond alternative. I Bonds are currently paying a fixed rate of 0.2% plus inflation and can be sold after five years with no penalty. Plus, federal taxes are deferred until you sell the I Bond. Clearly, I Bonds are a better investment than a 5-year TIPS.

If you haven’t bought I Bonds this year, you are probably holding out to see where the fixed rate is headed in the May 1 adjustment. If you absolutely, for certain want to lock in the 0.2% fixed rate, you need to buy before May 1. If you think the fixed rate will be going up, you should hold off buying until after May 1.

With a 10-year TIPS currently yielding 0.51%, I can’t see the Treasury raising the fixed rate higher than 0.2%. And with inflation running at extremely low levels, the Treasury could kill demand for I Bonds if it lowers the fixed rate back to 0.0%, where it was for several years.

So my wild guess is that the fixed rate will remain at 0.2%. The Treasury can sometimes surprise you though – like it did last November when it raised the fixed rate to 0.2% for no apparent reason.

By the way, I bought my I Bond allocation back in February. I’m not much of gambler.

Posted in I Bond, Investing in TIPS, Savings Bond | Tagged , , , | 8 Comments

When the Fed begins raising rates, what will happen to TIPS?

Janet Yellen, the Federal Reserve chair, set off a lot of turmoil in the markets on March 19  by hinting that the federal funds rate – which sets a base for short-term interest rates – could begin rising ‘around six months, that type of thing‘ after the Fed’s bond-buying program ends later this year.

That comment, at a news conference, sent the bond and stock markets into a tizzy. Yellen’s off-the-cuff comment implied that rates could begin rising in mid 2015 instead of  late 2015 early 2016, as the markets expected.

Since then, Yellen and the Fed have backed off, saying there is no timetable for increases in the federal funds rate. But the Federal Reserve itself is forecasting that its benchmark rate – now close to zero – will rise at least to 1% at the end of 2015 and to 2.25% by the end of 2016.

So let’s assume that the federal funds rate does rise to 2.25% at the end of 2016. How will that affect the prices and yields of Treasury Inflation-Protected Securities?

fed funds historyNo surprise. Rates are going up. No one can say this for certain, of course, and it depends on three things happening: 1) the U.S. economy must continue to improve, 2) the inflation rate must reach or at least approach the target level of 2%, and 3) the Federal Reserve must have the courage to raise rates when 1 and 2 are achieved.

But if these three things happen – and this is the most likely scenario, in my opinion – we will see the federal funds rate at 2.25% at the end of 2016 (or earlier), and we will see yields rise for both nominal Treasurys and TIPS.

So let’s take a look at the history of the federal funds rate; I have included some numbers from the past in the chart at the right. If you want to see the data, check out this site. What you will find is that 2.25% is a historically low rate. Today’s ultra-low fed rate – at a time when the stock market is hitting all-time highs – looks as out of place as that 20.06% number from January 1981.

So, the point is, there would be nothing extraordinary about a 2.25% fed rate, and in fact, it historically would have been a rate meant to spur economic growth, not deter it.

My next step was to look at times when the fed rate stood at 2.25% and cross-check the then-current yields for nominal Treasurys and TIPS. Here is what I found when I did the calculations on March 27:

Compare fed rateYes, the data are limited for several reasons: 1) TIPS have been in existence only since 1997, 2) a federal funds rate of 2.25% is relatively rare and 3) 30-year TIPS auctions were halted from October 2011 to February 2010, so there are no comparable data for 30-year TIPS.

But using these numbers as guidelines, I think we can make predictions about where interest rates are headed (not precisely, but an estimate) when the fed funds rate reaches 2.25%. I am using the average of each range to determine these numbers:

  • 5-year Treasury yields will increase 149 basis points
  • 5-year TIPS yields will rise 82 basis points
  • 10-year Treasury yields will rise 120 basis points
  • 10-year TIPS yields will rise 97 basis points
  • 30-year Treasury yields will rise 82 basis points
  • 30-year TIPS yields will rise an undetermined amount

Continuing on with this premise, let’s say the 10-year TIPS yield rises 97 basis points by the end of 2016, reaching a level of 1.53%. That’s perfectly reasonable by historical standards (probably even conservative), and it would equate to a 10-year nominal Treasury rate of 3.89%, creating an inflation breakeven point of 2.36%, also perfectly reasonable.

This sort of rise – 97 basis points – is definitely possible. In fact, we saw that happen in less than three months in 2013, when the 10-year TIPS yield rose from -0.74% on April 5 to 0.29% in June 19, a rise of 103 basis points.

What does this mean? If you are invested in a diversified TIPS mutual fund and this scenario plays out, you are going to see a drop in net asset value of about 8%. At the same time, you would benefit from a higher yield in the future.

The TIP ETF, which invests in a broad range of maturities, has a duration of 7.65, meaning its net asset value should decline by 7.65% when yields rise 100 basis points. That played out just as predicted during the 103 basis point rise in the 10-year TIPS from April 5, 2013 to June 19, 2013:

2013 tips decline

Looking into the future. The TIP ETF currently trades at $111.67, up about 1% so far this year. If it took an 8% hit, its net asset value would drop to $102.75, about where it was trading on Oct. 5, 2009, when a 10-year TIPS was yielding 1.51%.

I repeat: Perfectly reasonable. Will this happen? Who knows? But no one should be surprised if it does.

Posted in Investing in TIPS | 10 Comments

Will inflation rise again? A well-reasoned argument why that is a danger

Martin Feldstein

Martin Feldstein

In Monday’s Wall Street Journal, Martin Feldstein crafted a thoughtful and accessible argument on why the Federal Reserve is potentially moving toward igniting inflation by keeping short-term interest rates extremely low.

The article, titled ‘The Fed’s Missing Guidance,’ argues that Janet Yellen, chair of the Federal Reserve, needs to make clear today what the Fed will do if inflation rises above the annualized target of 2%.

Over the last 12 months, inflation rose just 1.1%, but Feldstein, a Harvard professor who was chairman of the Council of Economic Advisers under President Reagan, points out that it doesn’t take long for inflation to ignite.

The current consumer-price-index inflation rate of 1.1% is similar to the 1.2% average inflation rate in the first half of the 1960s. Inflation then rose quickly to 5.5% at the end of that decade and to 9% five years later. That surge was not due to oil prices, which remained under $3 per barrel until 1973.

Feldstein’s article also told me something I didn’t know about quantitative easing (the Fed’s bond-buying program), which he contends isn’t inflationary in itself, but has set up the framework for future inflation. In addition, the Federal Reserve has very few options to back out of the problem.

… the current inflation risk is not, as many people assume, that the Fed’s policy of quantitative easing has greatly expanded the money supply. Although the commercial banks received trillions of dollars of reserves in exchange for the assets that they sold to the Fed, these reserves were not converted into money balances but were deposited at the Federal Reserve, which now pays interest on such excess reserves. The broad money supply (M2) increased only about 6% in the past year.

In other words, instead of creating money, the Fed has pumped banking reserves to lofty levels. And there is the danger, because at any time those banks could begin freely lending that money to corporate borrowers. This would be a good thing at first, the economy needs expanded lending. But it the taps continue to flow freely as inflation rises, what then?

The big question is how the Fed will respond when the lending is excessive and leads to inflationary increases in demand?

Feldman goes point by point through the Fed’s options, but all the options have problems. Raise the federal funds rate? Banks won’t care because of the lofty reserves. Increase the interest rate it pays banks to hold their excess reserves at the Fed? Politically unpopular and expensive for the Fed.

So paying higher interest rates on excess reserves is not a viable strategy for limiting commercial bank lending, especially if the interest rate has to be raised substantially to limit inflationary pressures.

Another option would be to increase the banks’ required reserves, limiting their potential lending. Feldman doesn’t like this idea either. He argues that mildly raising short-term interest rates may not be enough to hold off inflation. And he wants to know, what exactly will the Fed do if inflation rises?

I think it is important for the Fed to explain now how it will prevent the banks from using their current short-term reserve assets to finance inflationary commercial lending in the future. If the public is convinced that the Fed is really committed to price stability, it will be less costly in unemployment to prevent or reverse future increases in inflation.

Posted in Inflation | Leave a comment

Repost: TreasuryDirect, TIPS and the dreaded 1099-OID

We are nearing the final days of tax season, so I am reposting a blog I wrote back on March 28, 2013, on investing in TIPS in a taxable account. In my case, my portfolio allocation works better that way, but I still contend it isn’t a horrible strategy. You prepay the taxes (horrors!) but get the full payout in retirement, no taxes due. The only problem is the 1099-OID tax form, which TreasuryDirect barely hints is available and makes as cryptic as possible. It is unlike any tax form provided by any investment company in the nation.

And so here is my post from 2013, minus some outdated stuff about 3o-year TIPS:

If you buy and hold Treasury Inflation-Protected Securities at TreasuryDirect, as I do, you’re violating a conventional wisdom rule of investing: Don’t hold TIPS in a taxable account.

I disagree with that conventional wisdom, more or less, but mainly because holding TIPS in a tax-deferred account generally means buying TIPS mutual funds instead of the actual issues. Or, a brokerage like Vanguard or Fidelity will allow you to buy TIPS at auction and hold them in an IRA account. But then you end up trying to find ways to invest and/or reinvest cash distributions and maturities.

So while holding TIPS in a tax-deferred account is preferable, I say holding them as a taxable investment at TreasuryDirect is also acceptable as part of your overall fixed-income asset allocation.

But, TIPS are different. TreasuryDirect, I have to say, is absolutely not user friendly. While every brokerage and investment firm on Earth mails you tax forms (or at least notifies you they are ready to download), TreasuryDirect does nothing. You will get nothing in the mail, you will not receive an e-mail alert. You are expected to remember to log in to TreasuryDirect.gov and retrieve your tax forms:

  • Form 1099-INT shows the sum of the semiannual interest payments made in a given year. This income is generated by the TIPS’ coupon rate, and is taxable at the federal level but tax-fee at the state.
  • Form 1099-OID shows the amount by which the principal of your TIPS increased due to inflation or decreased due to deflation. Increases in principal are taxable for the year in which they occur, even if your TIPS hasn’t matured, so you haven’t yet received a payment of principal.

So 1) you find your own tax forms, and 2) you print them and 3) these Treasury forms are like no other you’ll see from Vanguard or Merrill Lynch. They just list the amounts paid for each TIPS and give you a total. At the bottom are some definitions for IRS box numbers that are never specified on the form itself. Very weird. The Treasury could do better.

Form 1099-OID is the one behind the conventional wisdom to invest in TIPS in tax-deferred accounts. You are paying tax on money you have not yet received. This is often called ‘phantom income.’ However, if you have a Total Bond Fund or GNMA Fund in a taxable account and reinvest the dividends, or have a 5-year CD at a bank and are reinvesting interest, you are doing exactly the same thing. You are paying tax on money you have not yet received.

(Read this for a scholarly treatise, including incomprehensible formulas, debunking the conventional wisdom about holding TIPS in a taxable account.)

When the TIPS matures, here’s the good thing: You don’t owe any tax on the accumulated inflation-adjusted principal, because you’ve prepaid it. So if you bought a $10,000 10-year TIPS in 2010 and it matures in 2020 with a 23% inflation boost to principal, you get $12,300 and you owe no tax. This could work in your favor for allocating spending money in retirement.

But the dreaded 1099-OID is the big reason I Bonds are preferable to TIPS, especially when they offer a favorable return, as they do now for seven years up the maturity ladder. With I Bonds, your principal keeps increasing by the rate of inflation plus the base interest rate (which is currently 0.2% for new I Bonds). You owe no tax on I Bonds until you redeem them, and you can hold them for 5 to 30 years before redeeming without any penalty. (This paragraph was updated for 2014.)

I Bonds also offer a strategic advantage for retirement spending money because you could redeem them gradually to space out the tax owed. They are the ultimately flexible super-safe investment: 1) inflation protected, 2) deflation protected, 3) tax protected and 4) you choose the maturity date.

Posted in Investing in TIPS | 2 Comments