Up next: New 10-year TIPS auction July 24, 2014

The US Treasury hasn’t posted the formal announcement yet (it will be coming later this morning), but we know it will auction a new 10-year Treasury Inflation-Protected Security on Thursday, July 24. It will be CUSIP 912828WU0, and because this is a new issue, both the coupon rate and yield to maturity will be set when the auction ends.

Advantage of a new issue. Some TIPS followers don’t like the uncertainty of buying at auction, especially reopening auctions, because the price they pay can vary from what they expect. This happens when the yield to maturity is well above or below the coupon rate. This happens with reopenings, and the price swings can be dramatic (while somewhat predictable for those who follow the market).

But with a new issue, when the yield to maturity is above zero, the Treasury always sets the coupon rate one ‘click’ below the yield to maturity, meaning that buyers should be getting the TIPS at a slight discount, or at least extremely close to par after accrued interest is added in. The last two new-issue 10-year TIPS auctions demonstrate this:

CUSIP Auction Coupon Yield Per $100
912828B25 23-Jan-14 0.625% 0.661% 99.548
912828VM9 18-Jul-13 0.375% 0.384% 100.004

Disadvantage of a new issue. While there is less uncertainty about the dollar amount you will pay, a new issue isn’t currently trading on the secondary market and thus has no set coupon rate. Until the auction ends, you won’t know the coupon rate, or the yield to maturity, and this can be hard to predict for new issues. A new issue creates added ‘inventory’ for the TIPS market, and the pricing at auction can be slightly volatile.

What we know today about CUSIP 912828WU0. It’s possible that this new TIPS will auction with the lowest yield to maturity for any 9-to 10-year TIPS since May 2013, when the yield was -0.225%. Since then – for six consecutive auctions – the lowest yield to maturity has been 0.339%. Next Thursday’s yield could be lower:

  • Bloomberg’s Current Yields page is flashing a yield of 0.25% for a less-than 10-year TIPS currently trading on the secondary market.
  • The Wall Street Journal’s closing price chart is showing that a TIPS maturing Jan. 15, 2024, closed yesterday at 0.285%.
  • The Treasury’s Real Yield Curve chart – which estimates the price of a full-term 10-year TIPS – is showing a yield of 0.32% at the close Wednesday.

A lot can happen in a week, especially with a new issue, but right now we are looking at a yield of maybe 0.285% to 0.325% for this TIPS, and a coupon rate of 0.25%. The last new issue 10-year TIPS – auctioned Jan. 14, 2014 – went off with a yield of 0.661% and a coupon rate of 0.625%.

That’s a drop of more than 30 basis points in half a year, and it makes a big difference in the secondary market value of that TIPS. The January TIPS auctioned with a price of $99.548 per $100 of value, but now is much more expensive – about $103.15 on the secondary market. This price swing will work in reverse if (when?) interest rates begin to rise.

The inflation factor. One factor driving demand for TIPS – which causes yields to decline – is that inflation has been steadily rising this year. On top of the coupon rate, the principal balance of TIPS rises with the Consumer Price Index for all Urban Consumers (CPI-U). I chart recent inflation rates on my I Bonds page.

Inflation is currently running at 2.1% over the last 12 months. However – and this is crucial for buyers at next Thursday’s auction – the June 2014 inflation number will be announced Tuesday at 8:30 a.m. That number could have an effect on TIPS prices. Wait to see that number, and the reaction in TIPS prices, before making a buying decision.

Inflation breakeven rate. With the nominal 10-year Treasury closing yesterday at 2.55% and a 10-year TIPS at 0.32%, this creates a 10-year inflation breakeven rate of 2.23%. This means that if inflation averages more than 2.23% over the next 10 years, a TIPS will outperform at traditional Treasury. Back in January, the last new TIPS auction generated a breakeven rate of 2.12% — more attractive, in my opinion.

In summary, next week’s TIPS auction is not looking like an attractive buying opportunity. If you believe interest rates will be rising in the next few months, you will have an opportunity to get this same TIPS at a discount at reopening auctions in September and November. On the other hand, if you believe inflation will continue to rise without interest rates rising, this issue could be appealing.

Here is a chart of recent 9- to 10-year TIPS auctions showing how yields have risen from negative levels of 2012 to 2013, but remain well below historical norms:

10-year TIPS history

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8 Responses to Up next: New 10-year TIPS auction July 24, 2014

  1. Len says:

    I wonder, has it never occurred to anyone but me that it would be easy for the Treasury to manipulate the TIPS yield by controlling the supply? Restrict the supply, prices rise, yields fall. After all they issue billions in debt every month and who decides how much will issued as TIPS?
    If this seems farfetched well some 20 years ago Solomon Brothers, then a primary dealer, was caught rigging the 2 year note auctions. Just an idle thought as I have no evidence to submit.

  2. tipswatch says:

    Len, the Federal Reserve has been manipulating the price of TIPS and long-term Treasurys for nearly 2 years, for a long time buying $85 billion of Treasurys and mortgage-backed securities a month, and even with tapering it is still buying $20 billion a month of Treasurys as it tapers this program away. Those purchases definitely force yields down. But as the Fed has been tapering, China has been buying more Treasurys this year to hold down the value of its currency. So this has also ‘manipulated’ yields lower.

    More on the China purchases: http://online.wsj.com/articles/china-plays-a-big-role-as-u-s-treasury-yields-fall-1405545034

  3. Bob says:

    Restricting the new supply of TIPS could only cause yields to fall a tiny amount for at least a couple of reasons: 1) There is a large supply of TIPS outstanding and 2) TIPS compete with nominal Treasuries. The market keeps TIPS yields in synch with the yields on nominals based on the market’s inflationary expectations.

    On a technical note. Subject to a 1/8% minimum, the coupon is set in 1/8% increments equal to or below the accepted yield. So for example, if the yield comes in from 0.250% to 0.374%, the coupon will be 0.25%. If it comes in at 0.249% or lower, the coupon will be 0.125%. So if the yield is 0.125% or more, the bonds will sell at par or at a slight discount. But if the yield is below 0.125% the price will be at a premium.

  4. tipswatch says:

    Bob, excellent point about the 0.125%, because next week’s auction could actually threaten to go below that level. Because of the events today in the Ukraine and Israel, the 10-year nominal Treasury dipped 8 basis points, to 2.47%. If international markets are roiled on Friday, Treasury yields will decline and so with TIPS yields. As you note, they are linked in that ‘inflation breakeven zone of 2% to 2.5%, generally. So if the 10-year Treasury drops to 2.2%, for example, the 10-year TIPS could move to zero or negative. The Treasury will then set the coupon rate to 0.125% and buyers will be paying up for that rate.

  5. Jimbo says:

    Well, it’s been just over a year now that I’ve been dabbing in the TIPS market. Oddly enough, the yields are almost exactly what they were a year ago.

    Right now, you have to go all the way out to 1/2023 to find a TIPS with a positive YTM. From a buyer’s perspective, that isn’t very attractive.

    From a seller’s perspective, 2014 has been a pretty good year. When can you get 3% real gain in a month, it’s hard not to sell them.

    Originally, my plan was to slowly buy TIPS for the inflation protection and hold them to maturity. Of course, that plan was based on the assumption that interest rates would be rising this year.

    So far, I’ve sold off about 20% of the TIPS that I had. With the latest drop in rates, I’ve got a few more bonds that would provide a 5% real gain (in just three months).

    I really don’t want to sell anymore of these bonds. But, when you can get about 2 years of inflation coverage by selling, it just seems like the logical thing to do.

    This is particularly true with the Fed winding down it’s bond purchases and hinting at raising rates in the next couple of years. When rates are higher, this will be a much harder game to play.

    Since all of the bonds that I’ve been selling have maturity dates of 2023 (and pretty crummy coupons), I haven’t been that emotionally attached to them anyway.

    • YellenzMellenz says:

      Jimbo:

      Good luck with the short term TIPS trading, however, always ask yourself “What do I know that the markets don’t know?” If the market is mispricing TIPS then it is likely only by a few basis points not by a few percentage points and any mispricings are presumably very quickly arbitraged away by HFTs before the retail trader is even conscious of their existence.

      You don’t play hoops with Lebron James, at least not for real money, I hope. Well, maybe you do, but I don’t, anyway.

  6. tipswatch says:

    JImbo, I am the buy-and-hold-to-maturity guy, but I can’t disagree with your selling strategy if you can do it with minimal commission costs and if you have a decent plan for stashing the money until you reinvest it. On the reverse side of your strategy, I have only made two TIPS purchases in the last three years, so I am also reacting to the market by not buying. I’ve had five TIPS mature in that time. It’s a tough market for buyers, but sweet for sellers who have reason to sell.

  7. Pingback: Before you buy that 10-year TIPS … consider an I Bond | Treasury Inflation-Protected Securities

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