The steepening real yield curve: What does it mean for TIPS investors?

By David Enna,

If you follow the bond market at all, you know that longer-term nominal yields have been inching higher since the beginning of the year, and longer-term real yields (meaning yields above inflation) have been climbing, too. But the action has been primarily focused on the 10+-year maturities, and that means that the yield curve is steepening.

Here’s the trend in nominal yields:

  • 4-week bill: Started the year at 0.09%, now at 0.03%, a decline of 6 basis points.
  • 5-year note: Started the year at 0.36%, now at 0.59%, an increase of 17 basis points.
  • 10-year note: Started the year at 0.93%, now at 1.37%, an increase of 44 basis points.
  • 30-year bond: Started the year at 1.66%, now at 2.21%, an increase of 55 basis points.

And for real yields:

  • 5-year TIPS: Started the year at -1.62%, now at -1.76%, a decrease of 14 basis points.
  • 10-year TIPS: Started the year at -1.08%, now at -0.79%, an increase of 29 basis points.
  • 30-year TIPS: Started the year at -0.39%, now at 0.08%, an increase of 47 basis points.

These moves higher in the longer terms are pretty dramatic in just two months, but at the same time, the shorter-term yields have actually declined. Here’s a chart comparing the Treasury’s real yield estimates for 5-, 10- and 30-year TIPS over the last 5+ years, with the simultaneous changes in the Federal Funds Rate during that period:

A couple of things are remarkably well demonstrated here: 1) Times of “easy money” (meaning times the Fed is holding short-term interest rates very low) tend to widen out the yield curve, and 2) times of tightening (when short-term interest rates are increasing) tend to flatten out the yield curve.

A flat yield curve, or the even more ominous inverted yield curve, is seen as an omen of upcoming economic distress. A widening yield curve, as we are seeing now, is considered a good omen for the economy. Certainly, talk in Congress of another $1.9 trillion in stimulus spending is having an effect on the longer yields.

The Federal Reserve has a lock on short-term interest rates, and Fed Chairman Jerome Powell made clear this week that very low short-term rates will continue well into the future. And he said he didn’t think increased stimulus spending would trigger higher inflation:

“Inflation dynamics do change over time but they don’t change on a dime, and so we don’t really see how a burst of fiscal support or spending that doesn’t last for many years would actually change those inflation dynamics.” …

But while the Fed can control short-term interest rates, it can only “influence” longer-term interest rates, which are much more market driven. The Fed is continuing asset purchases to stabilize the Treasury market, but hasn’t stepped up those efforts in 2021 as longer-term rates have been increasing.

And in fact, the Fed could be allowing longer-term rates to creep higher in an effort to cool speculation in stock and currency markets. From a MarketWatch report:

“The Fed is not bothered by the move and may be slow to fight it,” said Mark Cabana, head of U.S. rates strategy at BofA Global Research, in a Wednesday note. …

“It seems so far that what the Fed is viewing in the bond market as constructive,” said Padhraic Garvey, regional head of research for the Americas at ING, in an interview.

What this means for the TIPS market

If you are an investor in TIPS mutual funds or ETFs, you’ve probably seen the value of your holdings decline this year, after a very good performance in 2020. When real yields rise, the value of a TIPS declines. The TIPS universe includes only 46 total issues, and of those, 18 have maturities of 0 to 5 years, and 34 have maturities under 10 years.

So given the events of 2021 so far, you’d expect that a short-term TIPS ETF (like Vanguard’s VTIP, which holds 0-5 year maturities) to be outperforming a broad-based TIPS ETF (like iShare’s TIP, with 1-30 year maturities) or a longer-term TIPS ETF (like Pimco’s LTPZ, with TIPS of 15+ year maturities).

And that is what is happening, as this stock chart shows:

Will this trend continue?

Anything I say is pure speculation, okay? But yes, I think this trend could continue, as long as the Fed remains committed to holding short-term interest rates near zero, while also allowing the longer-term yields to climb higher.

No matter what happens in the rest of 2021, I think the Fed will resist the urge to force short-term interest rates higher. And if the pandemic wanes and the economy gradually improves, the Fed shouldn’t be overly worried as yields creep higher for longer-term bonds.

But what if the stock market hits a deep correction or even falls into a bear market? Then the Fed, as it always does, will attempt to come to the stock market’s rescue. And at that point it will try to force longer-term rates lower through aggressive bond buying. Just my opinion.

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Investing in TIPS | 8 Comments

One day after weak auction demand, 30-year TIPS yield climbs above zero

By David Enna,

The Treasury’s offering of a new 30-year TIPS auctioned Thursday to weak demand, generating an above-current-market real yield of -0.04%, about 6 basis points more than expected. Then, one day later, the Treasury’s estimate of 30-year real yield broke above zero, to 0.03%, rising above zero for the first time since June 9, 2020.

Here is that trend over the last year, up to Thursday’s market close:

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So, the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or below) inflation.

TIPS real yields have been negative to inflation, across all maturities, for about 8 months, so this move on Friday is significant. Investors are seeking higher nominal and real yields, especially in the long maturities. The nominal yield for the traditional 30-year Treasury bond also has been climbing, from 1.66% on Jan. 4, 2021, to 2.14% at the market close on Friday.

The TIPS that auctioned Thursday, CUSIP 912810SV1, got a coupon rate of 0.125%, so investors had to pay a premium, an adjusted price of about $105.01, because the real yield was below the coupon rate. As of Friday’s market close, the price on the secondary market had dropped to $103.06, a fall of nearly 2% in a single day. This demonstrates the volatility of 30-year Treasury issues.

The next TIPS auction, on March 18, will be for a reopened 10-year TIPS, CUSIP 91282CBF7, but 10-year real yields remain well below zero. As of Friday’s close, this TIPS was trading with a real yield of -0.82%. The originating auction on Jan. 21 got a real yield of -0.987%, so 10-year real yields are also climbing.

This is from a Reuters report after the market close Friday:

“The bond market’s trying to reprice the fact that the Treasury is going to borrow more money to pay for the stimulus package,” said Tom di Galoma, a managing director at Seaport Global Holdings in New York. …

Meanwhile, the 30-year TIPS yield, which had been in negative territory since June, surpassed the 0% mark, rising after a weak auction of $9 billion of the securities on Thursday. …

“It’s hard to build a fundamental case for 30-year TIPS yields to be negative forever,” said Jim Vogel, senior rates strategist at FHN Financial in Memphis, Tennessee. “Over 30 years, that’s a lot of Fed accommodation for a long time.”

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Investing in TIPS | 6 Comments