New 10-year TIPS auctions with a real yield of -0.540%

The auctioned real yield came in higher than current market pricing, indicating fairly weak demand for this offering.

By David Enna, Tipswatch.com

The Treasury’s offering of $16 billion in a new 10-year Treasury Inflation-Protected Security — CUSIP 91282CDX6 — generated a real yield to maturity of -0.540%, above current market yields for TIPS of this term. The issue got a coupon rate of 0.125%, the lowest the Treasury will go for any TIPS.

At the market close yesterday, the U.S. Treasury was estimating the 10-year real yield at -0.57%, a bit lower than today’s result. In addition, a 9-year, 6-month TIPS was trading this morning on the secondary market with a real yield of -0.65%, well below the auction result.

So it looks like this auction was met with lukewarm demand and the Treasury was forced to give this TIPS a slightly higher real yield than predicted. The question: Are investors sitting on the sidelines, waiting to see how interest rates will trend in coming months?

Today’s investors paid an adjusted price of about $107.81 for about $100.25 of value, after accrued inflation is added in. This TIPS will have an inflation index of 1.00253 on the settlement date of Jan. 31. Investors had to pay a premium price because the real yield of -0.540% is well below the coupon rate of 0.125%.

So, it looks like investors got a bit of a bargain at today’s auction. The real yield of -0.540% was the highest recorded for any 9- to 10-year TIPS auction since May 2020.

Real yields have been climbing in recent weeks, following signals that the Federal Reserve intends to stop bond-buying stimulus in March, and then begin raising short-term interest rates. Here is the trend in 10-year real yields over the last year, showing how yields have climbed since deep lows in August and November 2021:

Inflation breakeven rate

With a 10-year Treasury note trading with a nominal yield of 1.83% at the auction’s close, this new TIPS gets an inflation breakeven rate of 2.37%, which seems attractive. The rate means this TIPS will out-perform a nominal 10-year Treasury if inflation averages more than 2.37% over the next 10 years.

Inflation expectations have been falling since late 2021, triggered by investor belief that the Federal Reserve will take needed actions to tamp down soaring inflation. Here is the trend in the 10-year inflation breakeven rate over the last year.

Reaction to the auction

The TIP ETF — which holds the full range of maturities — had been trading higher all morning, indicating lower yields. But after the auction’s close at 1 p.m. EST, the ETF slipped lower. This is an indication of lukewarm support for the auction. In addition, the bid-to-cover ratio was 2.30, the lowest for any TIPS auction of this term in more than a year.

The Treasury might be disappointed — it had to pay a slightly higher yield than expected — but investors at today’s auction should be pleased. The real yield of -0.54% was 60 basis points higher than the most recent auction of this term. That auction, in November 2021, resulted in a record-low real yield of -1.145%.

Personal note: I considered making a small investment in this TIPS in my Vanguard brokerage account , but I didn’t realize that Vanguard closes off auction orders at 10 a.m. on the morning of the auction. I swear it was 9:55 a.m. when I looked to make an order, but I got cut off. Lesson learned. I don’t know if this is true at other brokerages.

Anyway, this TIPS will get reopening auctions in March and May. Maybe we will see even better yields by then. Here’s a history of recent auctions, showing the string of 11 auctions of this term with negative real yields.

* * *

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses 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 | 5 Comments

A 10-year TIPS matured Jan. 15. How did it do as an investment?

CUSIP 912828SA9 was the first-ever 10-year TIPS to auction with a negative real yield. Still, it ended up out-performing its nominal counterpart.

By David Enna, Tipswatch.com

On January 15, 2022, a 10-year TIPS — CUSIP 912828SA9 — matured. It was first auctioned on Jan. 19, 2012, with a real yield to maturity of -0.046% and a coupon rate of 0.125%. That auction made history as the first-ever 10-year TIPS to receive a negative real yield. The numbers are uninspiring, but look fairly attractive today after a decade of much lower negative real yields.

Here’s the question: How did CUSIP 912828SA9 do as an investment versus a nominal 10-year Treasury? It turns out … well … it did OK.

I’ve been writing about Treasury Inflation-Protected Securities since 2011, and I’ve been investing in these products since 1999. I track the performance of every maturing 10-year and 5-year TIPS, as they mature in January, April and July. For more on this, see my ‘Tips vs. Nominals‘ page.

Here’s what I wrote back on Jan. 9, 2012, in my preview article about CUSIP 912828SA9:

The 10-year TIPS auction of Jan. 19 will be interesting to watch. Will it make history with a first-ever negative yield for a 10-year TIPS? And is that still attractive to buyers? … We are certainly entering uncharted waters for Treasury yields. Uncharted waters ought to make you uneasy. A negative real return over the next 10 years ought to make you uneasy. But there are no super-safe alternatives, and TIPS protect you against an unexpected rise in inflation.

On the day CUSIP 912828SA9 auctioned, a nominal 10-year Treasury was yielding 2.01%, creating an inflation breakeven rate of 2.06%. As it turned out, thanks to some lofty inflation numbers in recent months, inflation over those 10 years averaged 2.1%, and the TIPS investment ended up being the winner, by a small margin.

In general, 10-year TIPS have performed better when the inflation breakeven rate dips below 2.0%. Right now the 10-year breakeven is about 2.46%. Does that make a 10-year TIPS unattractive? I’d say no.

TIPS have been under-performing nominal Treasurys for most of the last decade because inflation for much of that time ran lower than expectations. We seem to have turned the corner on that, with official U.S. inflation now running at 7.0%, much higher than expectations. Will that trend continue? It seems likely, for awhile at least.

Here is how 10-year TIPS have performed versus 10-year Treasury notes for all maturities since July 2013:

Annualized inflation data from Eyebonds.info, based on CPI-U index 2 months before TIPS issue and maturity. Chart shows only new issues.

Notes and qualifications

This chart is an estimate of performance, because it uses a full month of inflation in the ending month, when actually TIPS accruals are based on a half month for the first and last months, with the origination and maturity occurring on the 15th of the month.

Keep in mind that interest on a nominal Treasury and the TIPS coupon rate is paid out as current-year income and not reinvested. So in the case of a nominal Treasury, the interest earned could be reinvested elsewhere, which would potentially boost the gain. For certain, we don’t know what the investor could have earned precisely on an investment after re-investments.

In the case of a TIPS, the inflation adjustment compounds over time, and that will give TIPS a slight boost in return that isn’t reflected in the “average inflation” numbers presented in the chart.

* * *

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

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

Posted in Inflation, Investing in TIPS | 3 Comments

10-year TIPS auction: Real yields are rising

Thursday’s auction of a new 10-year TIPS will get a real yield nearly 50 basis points higher than a similar auction in November. But is that enough?

By David Enna, Tipswatch.com

The U.S. Treasury will offer a new 10-year Treasury Inflation-Protected Security at auction on Thursday, and the real yield to maturity will almost certainly be a negative number. A negative yield? Does that mean investors will earn less than zero on this investment? Of course not.

I bring this up because the New York Times ran an article this week implying that investors in TIPS are guaranteed to lose money on their investment. Utterly ridiculous, and the New York Times should know better. Here is what the Times reported:

“People assume ‘just because inflation goes up, you’ll do well’ with TIPS, said Lynn K. Opp, a financial adviser with Raymond James in Walnut Creek, Calif. But other factors, like rising interest rates, can sap TIPS’s returns, she said.

“Plus, TIPS are expensive when compared with standard Treasuries in that they pay less interest, Ms. Opp said. In the first week of January, a five-year TIPS was yielding minus 1.7 percent, while a five-year Treasury was yielding 1.4 percent. In effect, TIPS investors were paying the Treasury to hold their money.

No. No. No. I know that TIPS can be a complicated investment to understand, but any financial advisor should know that a real return of -1.7% means only that the investment will lag official U.S. inflation by 1.7% a year over its term. Inflation currently is running at 7.0%, which translates to a nominal return of 5.3% for that TIPS, much better than the nominal Treasury at 1.4%. If inflation falls to 4%, that TIPS would yield 2.3%, still much better than 1.4%.

A negative real return does not mean a negative nominal return. And a positive nominal return — as you can get on that 5-year Treasury paying 1.4% — does not mean a positive real return. Simple as that.

One more point on that Times article: A 5-year TIPS never had an estimated real yield of -1.70% in January. The lowest it got was -1.56% on Jan. 4, and that yield had increased to -1.24% on the date the article was published. This is sloppy reporting. TIPS have pluses and minuses, but paying the Treasury to hold your money is not an issue.

Rant over. On to the auction.

The Treasury on Thursday will offer $16 billion in a new 10-year TIPS — CUSIP 91282CDX6. The real yield to maturity and coupon rate will be set by the auction, but we can be sure the real yield will be negative and the coupon rate will be set to 0.125%, the lowest the Treasury will go on a TIPS.

The best source for estimating the real yield of a new TIPS is the U.S. Treasury’s Real Yields Curve page, which updates an estimate each day at the close of trading. As of Friday’s market close the Treasury was estimating that a full-term 10-year TIPS would yield -0.66%, which is up 31 basis points from the start of the year.

Real yields (and nominal yields, too) have been rising after the Federal Reserve signaled it is ready to end its aggressive bond buying by March, and also likely to begin raising short-term interest rates in that month. We could see as many as four increases in short-term rates in 2022, and eventually, the Fed should begin reducing its $8.8 trillion stockpile of Treasurys and mortgage-backed securities.

So we could see real yields continue to climb before Thursday’s auction, but both the bond and stock markets seem to be heading into a volatile phase.

If the auction does result in a real yield of -0.66%, that should result (roughly) in an unadjusted price for investors of about $107.85 for $100 of par value. This TIPS will carry an inflation index of 1.00253 on the settlement date of Jan. 31, which means the adjusted price should be around $108.12 for $100.25 of value, after accrued inflation is added in.

Reminder: that’s a rough estimate, and things change. But investors should be prepared for that higher cost, which is necessary because the real yield to maturity will be well below the coupon rate of 0.125%.

Is a real yield of -0.66% attractive? Hey, at least it is well above the record low of -1.145% set at a TIPS reopening auction in November. That TIPS carried a premium cost of 15%. So this TIPS should get a real yield about 48 basis points higher than investors accepted just two months ago.

The key question is: Will this trend of rising real yields continue through 2022, making later auctions of this term more attractive? I’d say that is likely, but nothing is certain. Here is the trend in 10-year real yields over the last three years:

This chart is interesting because it shows that 10-year real yields were closing in on 1.0% in early 2019, following a period of Federal Reserve tightening. That could be the “new normal” for 2023 and beyond if the Fed stays on course to raise rates and reduce its balance sheet. However … the Fed does change course quickly. Back in 2019, it backed off and began reducing interest rates after the stock market had a volatile month in December 2018. More on that.

Inflation breakeven rate

With a nominal 10-year Treasury note yielding 1.78%, a 10-year TIPS would currently have an inflation breakeven rate of 2.44%, which seems reasonable (and actually attractive). I can visualize inflation running at a rate of 3% or higher over the next decade, but that would be a dramatic break from the last decade of lower-than-expected inflation.

Simply put, a lower inflation breakeven rate indicates that a TIPS is getting more attractive versus a nominal Treasury of the same term. Would I want to invest in a 10-year Treasury yielding 1.78%? No. Would I want to invest in a TIPS that would lag official inflation by 0.66% over 10 years? Maybe, because the TIPS offers protection against unexpectedly high inflation. We could be entering an era of unexpectedly high inflation.

Here is the trend in the 10-year inflation breakeven rate over the last three years, showing the massive surge higher after the pandemic mania of March 2020, and the less dramatic dip lower in recent weeks, in reaction to the Federal Reserve’s potential actions to tamp down inflation:

Conclusion

I can see the appeal of this auction, with real yields rising nearly 50 basis points since the last auction of this term in November. But will we see higher real yields later this year? The Treasury schedules opening and reopening auctions of this term every other month, so there will be a lot of opportunities. I’ll probably pass.

Also, remember that the first $10,000 you invest in inflation production in 2022 should go to U.S. Series I Savings Bonds, which in effect have a real yield of 0.0%, 66 basis points higher than a 10-year TIPS. In reality, that means an I Bond is about 7.5% more valuable than a 10-year TIPS, plus it offers better deflation protection, a flexible term and tax-deferred interest.

Thursday’s auction result closes at 1 p.m. EST for non-competitive bids, like the ones made at TreasuryDirect or a brokerage. I’ll be reporting on the auction results soon after the close. In the meantime, here is the recent history of TIPS auctions of this term. Note that Thursday’s result will be the 11th consecutive auction with a negative real return:

* * *

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses 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

Podcast: ‘The Inflation Guy’ explains the December inflation report

“The Fed is in a real pickle. … Being on the tightening side of monetary policy is no fun.”

Here is this week’s “Cents and Sensibility” podcast from inflation guru Michael Ashton. I am a big fan of this podcast and Ashton’s work because he has deep knowledge of how inflation works, but can explain complex issues in an entertaining way.

His podcast intro: “Inflation continues to show broader and deeper, and now is entering the general business and consumer mindset. In this episode, Inflation Guy talks about the idea that year-over-year inflation may peak soon, but probably won’t go back to the old 2% level. In the long term? Well, that depends on whether the Fed can channel Paul Volcker, and worry less about breaking eggs and more about whether we can afford eggs.”

Have a listen:

You can subscribe to this podcast in all the traditional ways, or find it here.

Follow Ashton on Twitter at: https://twitter.com/inflation_guy

Who is Michael Ashton?

His audiences know him as the “Inflation Guy.” He is a pioneer in the U.S. inflation derivatives market. Before founding his company, Enduring Investments, Ashton worked in research, sales and trading for several large investment banks including Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003, when he traded the first interbank U.S. CPI swaps, and 2004 when he was the lead market maker for the CME’s CPI Futures contract, he has played an integral role in developing new instruments and methods for accessing and hedging various inflation exposures. In 2016, Mr. Ashton published What’s Wrong With Money? The Biggest Bubble of All. He is a graduate of Trinity University and lives in Morristown, New Jersey.

Have a question? Get the Inflation Guy app in the Apple App Store or Google Play, or email InflationGuy@enduringinvestments.com.

Posted in Inflation | 1 Comment

U.S. inflation surged 7.0% in 2021, the highest rate in 40 years

December all-items inflation increased 0.5%, slightly higher than expectations.

By David Enna, Tipswatch.com

This seemed impossible just 12 months ago, when U.S. inflation ran at 1.4% for 2020. But December’s price increases continued an ominous trend in 2021, with annual inflation ending the year at 7.0%, the highest rate in 40 years.

For December, the Consumer Price Index for All Urban Consumers increased 0.5% on a seasonally adjusted basis, the Bureau of Labor Statistics reported. That was slightly higher than the consensus estimate of 0.4%. Year-over-year inflation ran at 7.0%, the BLS said, slightly below the consensus.

This is the final inflation report of 2021, and the 7.0% increase for the year is the largest since 1981, when inflation ran at 8.9%. In the 40 years following 1981, end-of-the-year annual inflation has never exceeded 6.1%, until 2021.

Core inflation, which removes food and energy, rose 0.6% for December, following a 0.5% increase in November. Year-over-year core inflation was 5.5%, the highest annual increase since 1991. Inflation for both the month and the year were higher than expected.

Gasoline prices, usually a trigger for higher U.S. inflation, actually fell 0.5% in December, but are up 48.9% for the year. (Before seasonal adjustment, gasoline prices fell 2.2% in December.) When inflation rises without a boost from energy prices, you know it is surging across the economy. For example:

  • Food prices were up 0.5% for the month, and increased 6.3% for the year.
  • The index for fruits and vegetables increased rose 0.9% over the month.
  • On the other hand, the index for meats, poultry, fish, and eggs declined in December, falling 0.4% after rising at least 0.7% in each of the last seven months.
  • Shelter costs increased 0.4% for the month and 4.1% for the year.
  • Costs of used cars and trucks continued surging, rising 3.5% for the month and 37.3% for the year.
  • New vehicle prices rose 1.0% for the month and were up 11.8% for the year.
  • The apparel index rose 1.7% for the month, following a 1.3% increase in November.

To sum things up for 2021, The BLS stated:

“Major contributors to this increase include shelter (+4.1 percent) and used cars and trucks (+37.3 percent). However, the increase is broad-based, with virtually all component indexes showing increases over the past 12 months.”

Here is the U.S. inflation trend over the last year, showing the strong move higher for both all-items and core inflation since September:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances for TIPS and set future interest rates for I Bonds. For December, the BLS set the inflation index at 278.802, an increase of 0.31% over the November number.

Note that the non-seasonally adjusted increase of 0.31% lagged behind the adjusted inflation number of 0.5% for the month, most likely caused by the dip in gasoline prices, a decline of 2.1% before adjustment, but 0.5% after. These types of variations will balance out over a year.

For TIPS. The December inflation report means that principal balances for all TIPS will increase 0.31% in February, following a 0.49% increase in January. In February, balances for the year will be up 7.0%. Here are the new February Inflation Index Ratios for all TIPS.

For I Bonds. The December report is the third in a six-month series that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset May 2 based on inflation from September 2021 to March 2022. After three months, inflation has been running at 1.64%, which translates to an I Bond variable rate of 3.28%. Keep in mind that three months remain, and also that lagging non-seasonally adjusted inflation in November and December should reverse in coming months.

Here are the relevant numbers:

What this means for future interest rates

In congressional testimony this week, Federal Reserve Board Chairman Jerome Powell signaled strongly that the Fed is prepared to raise short-term interest rates in 2022, beginning as soon as March. It looks like three rate increases in 2022 are a sure thing, and if inflation continues at a high rate into the summer, four increases are likely. That would bring the Federal Funds Rate up to a range of 1.00% to 1.25% by the end of the year.

Today’s inflation report reinforces the need for Fed action. There were few surprises in this report, but it is clear that the inflationary surge is continuing. That could be a hard trend to break. The stock market is opening higher this morning, indicating that this report was “digestible,” at least.

Inflation is likely to continue at a very high rate at least through March, which more or less ensures that the Fed will need to make that initial rate hike. The markets seem prepared for it. It needs to happen.

Inflation guru Michael Ashton posted this today on his E-piphany site, which includes a ton of analysis of today’s report:

“The Fed is talking tough, but talk is cheap. They’re still easing at this hour! Eventually they’ll stop digging the hole. When will they start filling it in – not by raising rates which has small effect if any on inflation, but by selling bonds? Don’t hold your breath. …

“This was, sadly, not a very surprising report. Inflationary pressures remain broad and deep, and the Fed today is still purchasing bonds and adding more reserves to the system. … So now, they’re behind the curve and really need to catch up and get ahead of this process.”

* * *

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

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

Posted in I Bond, Inflation, Investing in TIPS | 13 Comments