The U.S. Treasury formally announced yesterday that it will auction a new-issue 30-year Treasury Inflation-Protected Security on Feb. 20. This is CUSIP 912810RF7, and the coupon rate and yield to maturity will be determined at auction. Here’s the fact sheet.
How this shapes up. Because this is a new issue with a positive yield, the coupon rate and yield to maturity should be fairly close. If the auction were today, the coupon rate might be 1.50% and the yield to maturity around 1.42%. But a lot can happen in a week. Here are some data sources to check before the auction:
- The Treasury’s Daily Real Yield Curve Rates, which right now are indicating a yield of 1.42%. That’s down about 16 basis point from where we opened the year.
- Bloomberg’s Current Yields, which reflects current trading but can be a little misleading. It shows the longest-term TIPS trading at the same 1.42%.
- The Wall Street Journal’s closing price list for TIPS, which shows that the TIPS maturing 2043 Feb 15 closed Thursday at 1.40%.
The yield trend line. The Treasury offers only three 30-year TIPS auctions a year – one new issue in February and two re-openings (June and October). In 2013, we saw just how volatile 30-year Treasurys can be. CUSIP 912810RA8 auctioned on Feb. 21, 2013, with a yield to maturity of 0.64%. It was reissued in June with a yield of 1.42% and in October at 1.33%. In just five months, this TIPS lost almost 19% of its value on the secondary market.
But the trend also indicates that 30-year TIPS yields have been fairly stable since mid-2013. Buyers at the June 2013 auction are sitting on a slight gain.
What is normal? My opinion: In ‘normal’ times a long-term TIPS should pay at least 2% above inflation. As the Federal Reserve ends its bond-buying stimulus and the economy continues to improve, we might start to see hints of ‘normal.’ To make my case, I present the history for every 29- to 30-year TIPS auction:
Inflation breakeven rate. The 30-year nominal Treasury is yielding 3.70% and with the 30-year TIPS yielding 1.42%, plus inflation, this sets up a breakeven rate of 2.28%. That means this TIPS will outperform a traditional Treasury if inflation averages more than 2.28% over the next 30 years. Not expensive, not cheap, as this chart shows:
Best purchased in a tax-deferred account. I have noted before that a 30-year TIPS can end up being a cash-flow drain until it matures. The reason: You have to pay taxes on the inflation-adjusted interest in the year it is earned, but you don’t see that money until maturity. This TIPS, with a coupon rate of around 1.5%, is going to be close to cash-flow neutral if inflation averages 2.5% over 30 years.
Example: Let’s say you buy $10,000 of this TIPS and the coupon rate is 1.5% and the inflation rate averages 2.5%. In the first year you will get $150 of interest and $250 in inflation-adjusted principal. That’s $400 total, and if your marginal tax rate is 38%, you would owe $152 in taxes. The TIPS paid you $150, so you are $2 cash flow negative.
My philosophy on TIPS is to buy and hold to maturity as a way to push inflation-protected money forward into retirement. Although I have bought 30-year TIPS in the past (and still own them), they no longer are in my target range. So I’ll pass on this. (Go ahead, Treasury, tempt me with 3.5% above inflation and watch me change me mind.)
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Ed, I guess that would depend on the likelihood of unexpectedly high inflation over long periods of time. Interesting thing right now is that we are experiencing unexpectedly low inflation, below the expected average of about 2.5%, so things can balance out. I’d like to see more about this ‘positive increment of yield,’ do you have any sources you can link to?
TIPS provide a benefit of full protection against unexpected higher inflation until maturity. This can be expressed as a positive increment of yield. Just now it has occurred to me that this positive increment might be greater for longer maturities. Ever see anything about this?