The Treasury will announce tomorrow that it will reopen CUSIP 912810RA8, creating a 29-year, 8-month Treasury Inflation-Protected Security that will auction Thursday, June 20. Update: Here is the announcement.
This TIPS will have something going for it that’s been extremely rare: a discount. It originally auctioned Feb. 21 with a coupon rate of 0.625%, and a yield to maturity of 0.639%. It is currently selling on the secondary market for about $87 for $100 of value and a yield of 1.132%.
Yields on TIPS have been rising sharply since May 1. According to the Treasury Resource Center, the yield on a 30-year TIPS rose from 0.44% on May 1 to 1.14% on June 11. That’s an increase of 70 basis points, and it makes this 30-year offering a lot more interesting.
Buyers will get around 1.14%, plus inflation, over 30 years. Sound appealing?
The negatives. There are a couple of caveats, though.
Number 1 is: Will you be holding this issue to maturity? If so, you need to be ready to ride out — and ignore — some wild price swings. This TIPS originally auctioned for $99.61 and has fallen to $87. That’s a drop of 12.7% in four months.
If you are holding to maturity, no problem. You’ll get your 1.14%, plus inflation, and you can ignore the market noise. But this brings up negative Number 2: Will you be alive in 30 years? This is especially important if you are buying this TIPS in a taxable account. Here’s why:
Let’s say you put $10,000 into this TIPS, which will pay that coupon rate of 0.625% on a principal balance that will rise with inflation. And let’s say inflation averages 2.5% over the next 30 years. You will owe current-year taxes on $313 a year, and that number will rise. If you are in a high tax bracket your bill will be maybe $140 a year. But the coupon on this TIPS will provide you with only $62.50 a year, not enough to pay the taxes owed.
So this TIPS will be cash-flow negative until maturity. If inflation escalates, it will be even more negative.
So you will want to live to maturity, to see that money you’ve been paying taxes on for 30 years. If you die, you lose.
This is why I prefer buying 10-year TIPS and having them mature at a set date in the future, when I can decide to spend the money or reinvest.
The appeal. A yield to maturity of 1.14% (or possibly higher) will be the best yield on any TIPS auctioned in more than two years. I can see the appeal of adding that to a TIPS portfolio, just to get a boost in income. It is still below the ‘more normal’ yield of 2% to 2.5% that long-term TIPS buyers expected in the past, as this chart shows:
Another positive is the inflation breakeven rate versus a nominal 30-year Treasury, which closed Wednesday with a yield of 3.33%, up 50 basis points since May 1. That sets the probable breakeven rate for this TIPS at 2.19%, and that number could drop a bit before the auction.
It’s not much of a gamble to expect inflation higher than 2.19% over the next 30 years.
One more thing to consider. If the Treasury follows its usual pattern – and I expect it will – this 30-year TIPS will be reopened one more time in October. So you’ll need to ask yourself: Where are rates headed over the next four months? Buy in June, or wait for October?
Also, a new 10-year TIPS is coming in July.