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

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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Next up: 10-year TIPS will reopen at auction Nov. 20, 2014

The Treasury later today will announce it is reopening CUSIP 912828WU0 at auction Nov. 20, creating a 9-year, 8-month Treasury Inflation-Protected Security with a coupon rate of 0.125%. Update: Here’s the announcement. This TIPS has a history:

  • It was first auctioned July 24, 2014, with a yield of 0.249% (plus inflation), just below the mark that would have set the coupon rate at 0.250%. So it ended up with the lowest possible coupon rate, 0.125%.
  • It was reissued Sept. 18, 2014, with a yield of 0.610%. Buyers at that auction – I was among them – got this TIPS at a big discount – about $95.72 per $100 of value.

Because it trades on the secondary market, we can track the current pricing for this TIPS, from our usual reference sources:

  • Bloomberg’s Current Yields chart shows it trading with a yield of 0.43% and a price of about $97.03 per $100 of value.
  • Wall Street Journal’s Closing Prices Chart shows it closed yesterday with a yield of 0.416%.
  • The Treasury’s Real Yields chart estimates that a full-term 10-year TIPS would auction today with a yield of 0.46% (a full-term TIPS would generate a slightly higher yield, so this looks accurate.)

As I noted, I was a buyer of this TIPS back in September because its yield made a bold move higher in the days before the auction. A few days before the auction, the TIPS was yielding 0.46%, about where it is today. But on Sept. 17, the day before the auction, August inflation came in a -0.2%, setting off deflation fears and roiling the TIPS market.

Yields rose 15 basis points, and I bought. (But I was expecting a yield of about 0.55%, not the resulting 0.610%. I’ll take every basis point I can get.)

I probably won’t be a buyer at next Thursday’s auction, but a lot can happen in a week. The October inflation report will be issued Thursday morning at 8:30 a.m. That should make things interesting.

I’ll be checking in on this auction next Thursday morning, along with the inflation numbers for October. Meanwhile, study this chart of all 9- to 10-year TIPS auctions since 2008:

10-year TIPS

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I don’t like this new I Bond interest rate, should I sell and invest elsewhere?

Savings-Bond-IThe Treasury announced this week that it is dropping the fixed rate on Series I Savings Bonds to 0.0% for new bonds sold through April 30, 2015, and lowering the inflation-adjusted rate for all I Bonds to 1.48% for six months. Some investors might be wondering: Should I sell out and put my money elsewhere?

NO!

This is not the time to be selling your I Bonds. If you already own I Bonds, the new fixed rate of 0.0% doesn’t matter, because that applies only to new I Bonds purchased through April 30. I Bonds are unusual investments, with two interest rates combining into a ‘composite’ rate. So the composite rate varies from I Bond to I Bond, depending on when you purchased it.

  • The fixed rate will never change. So if you bought an I Bond in 2014 with a fixed rate of 0.2%, it will continue to have a 0.2% fixed rate for the life of the bond. Purchases through April 30, 2015, will have a fixed rate of 0.0%. I Bonds I bought back in 2000 still carry a fixed rate of 3.4% and will continue to do so through 2030.
  • The inflation-adjusted rate changes each six months to reflect the running rate of inflation. That rate is currently set at 1.48% annualized. It will adjust again on May 1, 2015, for all I Bonds, no matter when they were purchased. (Although the effective start date of the new interest rate can vary depending on the month you bought the I Bond, a Treasury oddity.)

So you need to consider:

  • What is the fixed rate on your current holdings? If you have been buying I Bonds for many years, your fixed rates might range from 3.60% (May 2000) to 0.0% (November 2010, and often since). See a chart of the fixed-rate history.  If you have I Bonds with a fixed rate of 1% or above, these are valuable assets and you want to hold them as long as possible, right up to maturity if you can. I Bonds with a 0.0% fixed rate might be tempting targets to sell, but not just yet.
  • Why keep an I Bond with a 0.0% fixed rate? I am holding several of these, and I don’t plan to sell. The reason: The Treasury limits your purchases to $10,000 per person per year in TreasuryDirect, plus $5,000 in paper I Bonds in lieu of a tax refund. The goal in I Bond investing is to build a cache of inflation-protected money for use in the future. You can’t build your total when you are also selling.
  • Why did you buy I Bonds in the first place? I Bonds are possibly the most conservative investment on Earth, because they hedge against inflation with 100% safety. Plus your holdings grow tax-deferred and aren’t taxed at the state level. They carry easy terms — you can sell after one year with a minor penalty and after five years with no penalty. For example, they could be used for 1) college savings, 2) a future down payment on a home, or 3) future retirement income. If you were saving for college or a home, and the time comes to sell, then you should sell. But if you were saving for future retirement income, now is not the time to sell, unless you need the money to meet current expenses.
  • But I can get a 5-year bank CD paying 2.3%! Good point, and I think that’s a sensible investment. But I wouldn’t sell my tax-deferred  I Bonds, which are growing at the rate of inflation (at least) to invest in bank CD, which is immediately taxable and carries no inflation protection. These are compatible investments, use them both.

I often point out that a lot of very wealthy people buy I Bonds up to the limit every year and scheme to get that $5,000 tax refund to bolster their holdings. Why do that do that? They are already rich, right? And that is the point. I Bonds are excellent investment for capital preservation, pushing money safely into the future.

When should you sell I Bonds? When you need the money — for college, a home, expenses in retirement, even for a trip around the world. But not to invest that money elsewhere.

In the future, if the I Bond fixed rate rises to something like 1%, I could see the point in selling bonds with a 0.0% fixed rate for the new issues. You’d trigger income taxes, but the investment would still make sense. Your holdings would remain stable that calendar year, but you could invest other money in TIPS to bolster you inflation-protected assets.

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Treasury drops Series I Savings Bond fixed rate to 0.0%

Savings-Bond-IThe US Treasury just announced that is it lowering the fixed rate paid on Series I Savings Bonds to 0.0% for bonds purchased from Nov. 1, 2014, to April 30, 2015. It also announced that the new variable (inflation-adjusted) rate for I Bonds will be 1.48%, as I predicted back on Oct. 22.

This means I Bonds purchased through April 30, 2015 will carry a composite, annualized rate of 1.48% for six months.

The move to drop the fixed rate to 0.0% is a disappointment, because the fixed rate carries with an I Bond for its entire life, up to 30 years. The variable rate changes every six months for all I Bonds. But the Treasury did follow its typical pattern. With a 10-year TIPS yielding only 0.40% today (plus inflation), there wasn’t much justification in keeping the fixed rate above zero.

The fixed rate dropped to 0.0% in November 2010 and stayed there for three years, until November 2013, when the Treasury surprised everyone by raising the fixed rate to 0.2%. At the time, a 10-year TIPS was yielding 0.52%. That lasted six months, and the rate dipped to 0.1% in April 2014, and now to zero in November 2014.

Prediction. I bought my full allocation of I Bonds ($10,000 per person through TreasuryDirect) back in February, so I locked in that 0.2% fixed rate. I suspect most potential buyers have already purchased their 2014 allocation, so the Treasury won’t be selling a lot of I Bonds through Dec. 31, 2014.

In January, when the 2015 allocation limit reopens purchases, there won’t be any reason to buy, and smart investors will wait until later in 2015 to see if the fixed rate rises again. It will be reset on May 1 and Nov. 2, 2105. So the Treasury won’t be selling a lot of I Bonds in the first quarter of 2015, either.

EE Bonds. The Treasury also gave a little slap to holders of Series EE Savings Bonds purchased after May 2005, which were paying 0.5% interest annually with a guarantee to double the principal balance in 20 years. So if you hold these for 20 years, you get 3.5%. The Treasury today dropped the annual interest rate for all EE Bonds to 0.1%, but the 20-year guarantee still holds.

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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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