Treasury Inflation-Protected Securities

By David Enna, Tipswatch.com

The Treasury’s reopening auction of a 5-year Treasury Inflation-Protected Security — CUSIP 91282CQP9 — generated a real yield to maturity of 1.955%, a good result for investors.

Real and nominal Treasury yields moved higher late Wednesday after the Federal Reserve held short-term interest rates in a range of 3.50% to 3.75%. But dot-plot projections from Fed members made it clear that rate increases could be coming later in the year if U.S. inflation does not begin cooling.

I watched Kevin Warsh’s news conference and I’d say he tried valiantly to make things look calm at the Fed, but there is a lot of apparent dissent. Other than that, I can’t say I know much more, since I am on holiday in southern France.

Before the Fed meeting, the 5-year real yield had been hovering in an already-elevated range of 1.78% to 1.82%. So today’s auctioned real yield of 1.955% was a sharp move higher. Plus, the auction drew solid demand. The “when-issued” prediction was 1.96% and the bid-to-cover ratio was 2.61, also a good number.

The statistics indicate we are entering a period of higher real yields. Maybe short term? Maybe not?

Consider this: Two months ago, this same TIPS generated a real yield to maturity of 1.367% at its originating auction on April 23. Today’s result was 57 basis points higher. That’s a big move.

Here is the trend in the 5-year real yield over the last two years, showing that today’s move higher is still off highs of late 2023, early 2024, and early 2025:

Pricing

Because the real yield of 1.955% was well above the coupon rate of 1.25%, this TIPS auctioned at a strong discount, with an unadjusted price of 96.787926. It also will carry an inflation index of 1.02135 on the settlement date of June 30. Here is the resulting cost of a $10,000 par value investment at this auction:

• Par value: $10,ooo.
• Adjusted principal on settlement date: $10,000 x 1.02135 =$10,213.50.
• Cost of investment: $10,213.50 x 0.96787926 = $9,885.43
• + accrued interest of $26.51.

In summary, an investor purchasing $10,000 par value at this auction paid $9,885.43 for $10,213.50 of principal on the June 30 settlement date. From then on, the investor will earn accruals matching official U.S. inflation, plus 1.25% annual interest on adjusted principal. The accrued interest will be returned at the next coupon payment on Oct. 15, 2026.

Inflation breakeven rate

The 5-year Treasury note was trading with a nominal yield of 4.20% at the auction’s close, giving this TIPS an inflation breakeven rate of 2.25%, which seems low to me under current economic conditions. The originating auction in April got an inflation-breakeven rate of 2.58%. Inflation over the last 5 years, ending in May, has averaged 4.5%.

This week’s peace announcement, along with the potential for lower energy prices, is probably a big factor in easing inflation expectations.

Here is the trend in the 5-year inflation breakeven rate over the last two years, showing the strong move higher after the outbreak of war in the Middle East and the more recent move lower.

Thoughts

I spent the entire day in Aix-en-Provence, one of my favorite places on Earth, and really didn’t follow Treasury trends closely. I am assuming the Fed’s mixed messages created fears of rising short-term interest rates, and the 5-year TIPS maturity is the most sensitive, at auction, to those trends.

If you invested in this auction, or have other feedback or ideas, please start the discussion in the comments section. Without going into political rants, what did you think of Kevin Warsh’s performance? What should the Fed be doing? I will try to watch! Meanwhile, here is a history of 4- to 5-year TIPS auctions over the last two years.

• 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

• TIPS investor: Don’t over-think the threat of deflation

• Upcoming schedule of TIPS auctions

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Follow Tipswatch on X for updates on daily Treasury auctions and real yield trends (when I am not traveling).

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. Please stay on topic and avoid political tirades. NOTE: Comment threads can only be three responses deep. If you see that you cannot respond, create a new comment and reference the topic.

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.

By David Enna, Tipswatch.com

The U.S. Treasury on Thursday will auction $24 billion in a reopened 5-year Treasury Inflation-Protected Security, CUSIP 91282CQP9, creating a 4 year, 10-month TIPS.

The auction comes after months of surging real yields following the outbreak of war in the Mideast, surging energy costs and accelerating U.S. inflation. Since the war began on Feb. 28, the 5-year real yield has increased a remarkable 71 basis points.

At this point, however, the 5-year real yield is still well off its recent-history high of 2.59% set on Oct 3, 2023.

CUSIP 91282CQP9 had its originating auction April 23, when it got a real yield to maturity of 1.367%, well below the current market of 1.82%. Its coupon rate was set at 1.25%.

This TIPS trades on the secondary market, where it closed Friday with a real yield of 1.79% and a price of 97.51.

Definition: The “real yield to maturity” of a TIPS is its yield above future U.S. inflation, over the term of the TIPS. So a real yield of 1.79% means an investment in this TIPS would provide a return that exceeds official U.S. inflation by 1.79% for 4 years, 10 months.

Here is the trend in the 5-year real yield over the last 16 years, showing that the current yield remains in the high range for this maturity:

Volatile events

War and peace. As we entered this weekend, the U.S. and Iran appeared to be on the “cusp of peace,” a nice term the Wall Street Journal used in a Saturday headline. Or not. We all know how this goes — edge of peace to edge of war, within a day.

Any declaration of “peace” would likely set oil prices rolling back, a trend that is already underway, with the price of Brent crude falling from $112 on May 18 to $87 on Friday. But it could be long time before prices return to the pre-war level of about $69.

A true peace announcement could also send stock prices higher and provide relief for the Treasury market. Maybe.

The Federal Reserve. The Fed’s Open Market Committee will meet this week and at 2 p.m. ET Wednesday — 23 hours before the TIPS auction — we will hear that the federal funds rate is on hold. No surprise there, but because this will be the first meeting under the leadership of Chairman Kevin Warsh, markets will be watching closely.

Although Warsh has said he wants less public communication from the Fed, it is scheduled to release a “Summary of Economic Projections” and Warsh plans to hold a news conference after the meeting. So many questions:

• Will the FOMC statement drop its “easing bias,” signaling the possibility of future rate increases?
• Will Warsh suggest he is open to future rate increases, if needed?
• Will the governors go along with Warsh’s plans to reduce the Fed’s balance sheet, which could cause long-term rates to rise?
• What will the dot points predict for future interest rates, inflation and economic growth?
• How much dissent will we see from voting members of the board?

Because all this Fed news will break one day before Thursday’s TIPS auction, you can expect to see some ripple-effects in the auction’s real yield. Be aware of that coming volatility if you plan an investment.

Pricing

CUSIP 91282CQP9 closed Friday on the secondary market with a real yield of 1.79% and a price of 97.51. The price is discounted because the coupon rate of 1.25% is well below the current market yield. In addition, this TIPS will carry an inflation index of 1.02135 on the settlement date of June 30.

With that information, we can estimate the cost of a $10,000 par value investment at Thursday’s auction, based on Friday’s close. The numbers will certainly change by the auction, but this is a reasonable guide:

• Par value: $10,000.
• Principal purchased on settlement date: $10,000 x 1.02135 = $10,213.50
• Cost of investment: $10,213.50 x 0.9751 = $9,959.18.
• + $26.51 of accrued interest.

In summary, based on Friday’s close, an investor would pay $9,959.18 for $10,213.50 in principal as of the settlement date. From then on, the investor would earn inflation accruals and an annual coupon rate of 1.25% on adjusted principal until maturity.

Side note: In putting these numbers together, I was fascinated to see that non-seasonally adjusted inflation will have increased 2.13% in the 2 1/2 months this TIPS has existed, as of June 30. And let’s look out to July 31: This TIPS was first issued April 15 with an inflation index of 1.00000. On July 31, its inflation index will be 1.02788, an increase of 2.79% in 3 1/2 months. That is shocking.

Inflation breakeven rate

With the 5-year Treasury note closing Friday with a nominal yield of 4.21%, CUSIP 91282CQP9 currently has an inflation breakeven rate of 2.42%, a bit below recent auctions of this term. I’d expect a higher number. Inflation over the last five years ending in May has averaged 4.5%.

Here is the trend in the 5-year inflation breakeven rate over the last 16 years, showing the relatively stable (and unreliably low) pattern in recent years:

Alternatives

I Bonds. A Series I Savings Bond purchased today will get a composite rate of 4.26% for six months and a permanent fixed rate of 0.9%. The real yield of a 5-year TIPS is about twice that. A quick metric is to apply the 0.65 ratio to the TIPS’s real yield, which results in 1.16%. At this point, the TIPS appears more attractive despite the many good qualities of an I Bond — deflation protection, tax-deferred interest and better compounding of interest.

Bank CDs. Best-in-nation 5-year bank CDs are paying about 4.10%, slightly lagging the 5-year Treasury. I’d prefer the TIPS.

Thoughts

This will be an interesting auction, for sure, simply because of all the global and political events swirling this week. I won’t be a buyer because I have filled the 2031 rung of my TIPS ladder, with real yields ranging from 1.42% to 2.03%.

A real yield around 1.80% looks fine to me, but understand that if the Federal Reserve does begin increasing short-term rates, the 5-year real yield would likely climb higher.

If you want to invest, there is no need to commit to the auction. This TIPS can be purchased on the secondary market through a brokerage account. So if you see a real yield you like, you have that option.

The advantage of buying at auction, especially through TreasuryDirect, is that even small-lot purchases will get the auction’s high yield. The advantage of the secondary market is that you can see exactly the price and real yield you will be receiving. The negative is that you may face a small bid-ask spread. Most of the time, it doesn’t make a huge difference.

This TIPS auction closes Thursday at 1 p.m. ET. Non-competitive bids at TreasuryDirect must be placed by noon Thursday. If you are putting an order in through a brokerage, make sure to place your order Wednesday or very early Thursday, because brokers cut off auction orders before the noon deadline.

I will be posting the auction results sometime on Thursday. Here is a history of auction results for this term over the last 5 years:

• 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

• TIPS investor: Don’t over-think the threat of deflation

• Upcoming schedule of TIPS auctions

—————————

Donate? This site is free and I hope to keep it that way. Some readers have suggested having a way to contribute. I welcome donations, any amount. And FYI, ads on this site pay for about one visit to Costco.

PayPal link / Venmo link

—————————

Follow Tipswatch on X for updates on daily Treasury auctions and real yield trends (when I am not traveling).

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. Please stay on topic and avoid political tirades. NOTE: Comment threads can only be three responses deep. If you see that you cannot respond, create a new comment and reference the topic.

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.