I had a 10-year TIPS mature in July and I thought it would be interesting to look at how that Treasury Inflation-Protected Security performed against a traditional 10-year Treasury. Did it outperform? By how much?
So here are the basic details: The TIPS was CUSIP 912828BD1 and it was auctioned on July 9, 2003, with a coupon rate of 1.875% and a yield to maturity of 1.999%. That means this TIPS was sold at a discount to par, $98.881 for each $100 of value.
On the same day – July, 9, 2003 – the 10-year Treasury closed at 3.73%. This established an inflation breakeven rate of 1.731%. (3.73 minus 1.999 = 1.731%). I didn’t know it in 2003, but this was an excellent breakeven rate. It meant that if inflation averaged more than 1.731% over the next 10 years, this TIPS would outperform the nominal Treasury.
So, what happened? It turned out that the next 10 years were a period of extremely low inflation, averaging 2.4%, the lowest of any 10-year period in 50 years. There was a two-year period, from 2009 to 2010, when inflation was actually negative, falling -0.2%. (You can find detailed inflation data on eyebonds.info, a site that is loaded with data about TIPS and I Bonds.)
And yet, despite that weak inflation, this TIPS greatly outperformed the Treasury.
The lesson? The inflation breakeven rate does matter. When it falls below 2%, TIPS are cheap relative to Treasurys. When it rises above 2.5%, TIPS are expensive. (This assumes long-term inflation trends continue, we can never be sure.)
In September 2012, the 10-year breakeven rate rose above 2.6% and earlier this year above 2.5%, a rate that’s higher than the last 10 years of inflation. After weeks of turmoil in the bond markets, it has settled in about 2.21% after recently dipping below 2%.
Back in 2003, when the economy was still in shock from the Internet crash, investors were pricing in very low inflation (1.731%). That was fortunate for buyers of CUSIP 912828BD1.
And here are the numbers:
|$10,000 investment||10-year Treasury||10-year TIPS|
|Total interest paid||3,730.00||4,936.62|
|Actual yield to maturity||3.73%||4.43%|
Note: The 10-year Treasury in this example is theoretical, since there wasn’t a 10-year Treasury auction on July 9, 2003. The TIPS numbers are the actual interest payments from a $10,000 investment in CUSIP 912828BD1, reconstructed with data from eyebonds.info.