Real Yield In 5-Year TIPS Auction Drops To 0.152%

Summary

  • Five-year real yields have dropped nearly 100 basis points in the last six months. That’s a huge move in anticipation of Federal Reserve rate cuts.
  • Today’s real yield of 0.152% had to be a disappointment to investors, who also had to pay a premium price for this TIPS.
  • The five-year inflation breakeven rate climbed a bit to 1.60%, indicating somewhat stronger demand for inflation protection.

The Treasury’s $15 billion reopening auction of CUSIP 9128286N5 – creating a 4-year, 10-month Treasury Inflation-Protected Security – generated a real yield of 0.152%, dramatically lower than recent auctions of this term.

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This Week’s 5-Year TIPS Reopening Will Reset The Market

Summary

  • Expect volatility in the Treasury market this week because the Federal Reserve’s Open Market Committee will issue a statement Wednesday, one day before the auction.
  • At this point, CUSIP 128286N5 is heading toward a real yield of about 0.35%, 78 basis points below a similar auction in December. Buyers will be paying a premium price.
  • A very low inflation breakeven rate of about 1.48% should bring strong market demand for Thursday’s auction.

The U.S. Treasury on Thursday will reopen CUSIP 9128286N5, auctioning $15 billion of a 4-year, 10-month Treasury Inflation-Protected Security. This is an especially interesting auction because it follows six months of rather dramatic yield declines.

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VTIP: As Yields Sink, Consider Adding Inflation Protection

Summary

  • The Federal Reserve looks likely to begin cutting short-term rates in 2019, possibly as much as 75 basis points over the next year.
  • Yields for money market funds and short-term Treasurys will track lower with those rate cuts.
  • Inflation-protected investments could perform well in a time of falling rates and steady moderate inflation.

The “glorious” days of getting a 2% return on a very safe, very liquid investment are drawing to a close. Why? The Federal Reserve is on the brink of beginning a series of cuts to its Federal Funds rate, the nation’s key short-term interest rate.

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U.S. Inflation Slowed In May With Increase Of 0.1%

Summary

  • Both headline and core inflation numbers fell short of consensus estimates.
  • Gasoline prices fell 0.5% in May, following a 5.7% increase in April. Gas prices could be a deflationary force in coming months.
  • May’s mild inflation report leaves the door wide open for the Federal Reserve to begin cuts in short-term interest rates.

This report looks like good news for the stock and bond markets, because it reinforces the Federal Reserve’s likely plan to begin lowering short-term interest rates, possibly twice in 2019. The first cut could come next week, or possibly in July.

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FRNs: Their Time In The Spotlight Is About To End

Summary

  • FRNs, 2-year Treasury investments, have been in the news recently because their yields topped all Treasury investments with terms up to 10 years.
  • FRNs are attractive during a time of rising interest rates, especially for cash you know you will be holding for two years.
  • But during a period of declining rates – which could be coming – shorter-term investments give you more flexibility, with just a small yield penalty.

On May 31, a typical FRN was yielding about 2.4% while the 10-year Treasury yield had dropped to 2.14%. That means FRNs currently have about a 25 basis-point advantage over a 10-year Treasury. That’s a pretty remarkable example of yield inversion, because the FRN’s base interest rate matches the current 13-week Treasury.

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10-Year TIPS Reopening Generates A Real Yield Of 0.567%

Summary

  • The real yield of 0.567% was in line with where this TIPS was trading Thursday morning. No surprise, and the auction appears to have been met with strong demand.
  • Buyers had to pay a lofty premium, however, because the real yield fell well below the coupon rate of 0.875% generated at the originating auction in January.
  • The inflation breakeven rate came in at 1.73%, the lowest at auction for this term since September 2016.

Because the auctioned yield was well below the coupon rate, investors had to pay a premium price, about $103.54 for about $100.66 of value, after accrued inflation is added in.

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Take Caution: This Week’s 10-Year TIPS Reopening Will Be Pricey

Summary

  • The real yield is likely to come in around 0.57%, well below the coupon rate of 0.875%.
  • That means buyers could be paying a premium of nearly 3% to capture that coupon rate. Is that too high a price to pay?
  • The inflation breakeven rate is currently running at about 1.82%, meaning this TIPS is close to fair value versus a nominal Treasury.

The U.S. Treasury announced last week that it will offer $11 billion in a reopening auction Thursday of CUSIP 9128285W6, creating a 9-year, 8-month Treasury Inflation-Protected Security.

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