Thursday’s TIPS auction … a little strange

The Treasury on Thursday auctioned a reissue of a 10-year TIPS and it went off at a higher-than-expected yield of  0.099%, in addition to the inflation adjustment. This was nice news for the new buyers of this TIPS, since it had recently been trading in the secondary market with a negative real yield. On Wednesday, experts had predicted a yield of 0.06%.

So the TIPS auction generated a higher yield, while at the same time, yields on nominal Treasuries were declining. This chart paints the picture:

5 week pattern for TIPIt’s remarkable that intermediate Treasuries were peaking around noon Thursday, the time of this week’s auction, and at that same time the TIP ETF was hitting its low, down about 1% for the week.

Like I said, this is good news for the buyers at Thursday’s auction. The yield of 0.099%, while paltry by historical standards, seemed pretty generous in today’s market.

Consider this: On Thursday, the rate on a nominal 10-year Treasury dipped to 1.96%, the lowest yield for any day this month. And that shows why a 10-year TIPS, paying a near-zero real return, is so much more attractive than a 10-year Treasury.

10-year Treasury: Worst it can do = 1.96%. Best it can do = 1.96%.

10-year TIPS: Worst it can do = 0%, assuming 10 years of deflation. Best it can do = unlimited, matching the inflation rate plus 0.099%

The TIPS buyer does better over 10 years if inflation averages more than 1.861%. I can’t predict the future, but I suspect inflation will be higher than 1.861% over the next 10 years, possibly much higher.

From a Bloomberg report on the auction:

“It wasn’t a great auction,” said Michael Pond, co-head of interest-rate strategy in New York at primary dealer Barclays Plc. “There has been a flight to liquidity into nominal Treasuries, and when that happens these auctions can go much worse.”

It’s good to be reminded that TIPS and Treasuries don’t always track together. When nominal Treasury yields decline because of fears of deflation, TIPS can take a hit.

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