Treasury Inflation-Protected Securities

• The real yield looks likely to come in around 0.46%, down 63 basis points from the originating auction in February.
• Buyers will be paying a steep premium for the coupon rate of 1.0%, about 15% above par value.
• The inflation breakeven rate is currently running at a very low 1.57%, which should make this auction attractive for big-money investors.

Thursday’s reopening auction of CUSIP 912810SG4 – creating a 29-year, 6-months TIPS – is a particularly gruesome offering. The Treasury is selling $7 billion of this reopened TIPS, but no one outside of a central bank or pension fund should touch it.

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• The TIP ETF has had a total return of 8.33% so far in 2019, slightly outperforming the overall bond market.
• Shorter-term TIPS funds have also performed well, but the gain has been less dramatic.
• A relatively low 10-year inflation breakeven rate indicates that TIPS remain a solid choice versus nominal Treasurys. But TIPS funds are riskier today than they were a year ago.

Back on November 20, 2018 — yes, just nine months ago — I wrote an analysis of inflation-protected ETFs and asked, “Is It Time To Buy TIPS ETFs, Mutual Funds?” My conclusion was: Yes, the time is right, especially for shorter-term TIPS funds.

But I didn’t expect what would happen in the next nine months …

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• Both headline and core inflation numbers came in higher than expected, indicating inflation is not ‘dead’ and deflation is not looming.
• The July number sets a path for a 1.6% to 1.8% increase in the 2020 Social Security cost-of-living adjustment.
• At this point, with two months of data remaining, the I Bond’s variable rate will be higher than the current rate of 1.4%. It will be reset on November 1.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3% in July on a seasonally adjusted basis, the U.S.Bureau of Labor Statistics reported today. Over the last 12 months, “headline” inflation increased 1.8%.

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• The Social Security Administration uses a complex formula, and an unusual inflation index, to set the annual COLA increase.
• Once again, the Social Security COLA looks like it will be lower than overall U.S. inflation. (That wasn’t true for the 2019 increase, however.).
• At this point, a COLA increase in the range of 1.6% to 1.8% looks likely, but a lot can change in the only months that matter: July, August and September.

In its annual report issued in April, the Social Security Administration projected a likely 1.8% cost-of-living-adjustment (COLA) for Social Security recipients in 2020. That looks like a reasonable estimate, but possibly a bit high.

The COLA formula is ridiculously complex and little understood. Is it related to U.S. inflation? Yes, but not the inflation index you hear about each month. Does it reflect 12 months of U.S. inflation? Not really. Does it underestimate actual U.S. inflation? Most years, yes.

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• The real yield is likely to come in around 0.35%, more than 60 basis points below where these yields started the year.
• The inflation break-even rate was about 1.77% as of Friday. That might seem low, but it is a fair reflection of current inflation.
• The superior alternative is the U.S. Series I Savings Bond, currently offering a real yield of 0.50%, tax-deferred interest and a flexible maturity.

The U.S. Treasury will offer a new 10-year Treasury Inflation-Protected Security – CUSIP 9128287D6 – in a $14 billion auction Thursday, with the real yield likely to fall substantially below recent results for this term.

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• The monthly “headline” inflation number and core inflation for the month and year all came in higher than the consensus forecasts.
• Overall U.S. inflation is being held down by declining gasoline prices, but core inflation is running at 2.1%, which is clearly “moderate” inflation.
• The Federal Reserve probably won’t be swayed by these numbers, and will remain on track to begin lowering short-term interest rates this year.

The Consumer Price Index for All Urban Consumers increased 0.1% in June on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, “headline” inflation increased 1.6%.

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• Both real and nominal yields have plummeted in 2019, with nominal yields on government debt dipping into the negative in Europe and Asia.
• Returns on I Bonds and EE Bonds still have the same terms that the Treasury set in November 2018 and have now become much more attractive by comparison.
• I Bonds are the best inflation-protected Treasury investment with a maturity under 20 years. EE Bonds are the best nominal Treasury investment with a maturity of 20 or more years.

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