By David Enna, Tipswatch.com

The Treasury’s offering of $21 billion in a reopened 5-year Treasury Inflation-Protected Security — CUSIP 91282CKL4 — generated a real yield to maturity of 2.050%, slightly lower than expected.

The auction appears to have been met with decent demand. The “when-issued” prediction used by bond traders was set at 2.070% right before the auction’s close. In addition, the bid-to-cover ratio of 2.52 was in the solid range.

The yield came in below the April 18 originating auction‘s real yield of 2.242%, which set the coupon rate for this TIPS at 2.125%. However, this was only the third TIPS auction of this term to get a real yield higher than 2.0% since October 2008. There have been 50 auctions of 4- to 5-year TIPS since October 2008, so today’s result is significant.

This TIPS trades on the secondary market and earlier Thursday morning it was trading with a real yield of 2.08%. The auction result of 2.050% indicates demand was strong. Apparently, inflation protection still has some appeal.

Here is the trend in the 5-year real yield over the last four years:

Pricing

Because the real yield came in below the existing coupon rate of 2.125%, today’s investors had to pay a small premium at this auction. The unadjusted price was 100.338480. In addition, CUSIP 91282CKL4 will have an inflation index of 1.01332 on the settlement date of June 28.

This is how the pricing works out for a $10,000 par investment at today’s auction:

• Par value: $10,000
• Principal on settlement date: $10,000 x 1.01332 = $10,133.20
• Cost of investment: $10,133.20 x 1.00338480 = $10,167.50
• + $43.54 of accrued interest, which will be returned at the first coupon payment.

In summary, an investor purchasing $10,000 par at this auction paid $10,167.50 for $10,133.20 of principal, and will now receive accruals matching inflation plus a coupon rate of 2.125% until maturity on April 15, 2029.

Inflation breakeven rate

In my preview article for this auction, I noted that the market was setting a 5-year inflation breakeven rate of 2.12%, which seems low given current inflation trends. But this auction narrowed the gap, a bit. With a 5-year nominal Treasury trading at 4.28% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.23%.

That means it will outperform the nominal Treasury if inflation averages more than 2.23% over the next 4 years, 10 months. Seems like a reasonable bet.

Here is the trend in the 5-year inflation breakeven rate in the last four years:

Thoughts

There was nothing really out-of-the ordinary about this auction. The 5-year real yield closed Tuesday at 2.07%, pretty close to the result. A real yield of more than 2.0% is a solid investment, in my opinion. If you were a buyer, this looks good.

How good? Here is a history of TIPS auctions of this 4- to 5-year term, highlighting the lowest real yield in history, -1.685%, in an auction in October 2021. Since then, in less than three years, real yields have risen 373 basis points.

• Now is an ideal time to build a TIPS ladder

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• Upcoming schedule of TIPS auctions

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.