The US Treasury formally announced yesterday that it will reopen CUSIP 912810RF7 on Thursday, Oct. 23, creating a 29-year 4-month Treasury Inflation-Protected Security with a coupon rate of of 1.375%.
This TIPS initially auctioned on Feb. 20, 2014, with a yield to maturity of 1.495%. It reopened on June 19, 2014, with a yield of 1.116%, meaning buyers had to pay $108.34 for $100 of value to collect that coupon rate of 1.375%.
A lot has happened in the TIPS market in 2014. It’s been a roller-coaster ride, with the 30-year TIPS yield starting the year on Jan. 2 at 1.58% (the highest yield of 2014), declining to 0.98% on May 28, rising to 1.17% on June 10, falling to a 2014-low of 0.82% on Aug. 28, rising to 1.17% on Sept. 18, and closing yesterday at 0.89%.
What those numbers mean. CUSIP 912810RF7 is going to be expensive. Buyers at Thursday’s auction may be paying a nearly 13% premium to collect a coupon rate of 1.375%. In other words, $10,000 of this TIPS will cost a buyer $11,300. At maturity 29 years from now, the buyer will get back $10,000, plus inflation, while collecting $137.50 a year in interest (which will also rise with inflation).
This TIPS seems very risky as a trading vehicle, because an uptick in interest rates will send its market value plummeting. It only makes sense as a buy-and-hold investment, and a buyer is going to have to live 29 years, 4 months to get a return.
Let’s look at the current market for CUSIP 912810RF7:
- Bloomberg’s Current Values chart shows it trading today at 0.89% with a price of about $112.40 per $100 of value.
- The Wall Street Journal’s Closing Values chart shows that it ended Thursday with a yield of 0.865% and a price of about $112.72.
- The Treasury’s Real Yields chart, which estimates the yield of a full-term 30-year TIPS, sets yesterday’s close at 0.89%
A lot can happen in a week, especially with the stock market showing plenty of volatility this month. But it’s not likely that this TIPS, which is currently trading just 7 basis points above its low for 2014, which get a lot cheaper before next Thursday.
One interesting factor in Oct. 2014, however, is the dramatic fall in inflation breakeven rates across all TIPS maturities. With a nominal 30-year Treasury yielding 2.94%, we’re looking at a 30-year inflation breakeven rate of just 2.05% – very low. That means this TIPS is actually a pretty good buy against a traditional Treasury.
What are the chances that inflation will average less than 2.05% over the next 30 years? It could happen, sure, but take a look at this chart of historical inflation ranges. Going back to 1961, the lowest 30-year inflation rate average was 2.8%, for the 30-year period ending in 2013.
Nevertheless, if I were in the market for a 30-year TIPS – which I am not – I probably would wait until the February 2015 auction of a new issue, when the yield and coupon rate will be aligned – lowering my upfront cost on a very long-term investment.
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Hi, Joe … no formula, I was just using the Treasury announcement for that auction, which placed the price at $108.34.
Click to access R_20140619_1.pdf
Very roughly, you can say 1.375 – 1.116 = 0.259 x 30 = 7.77.
Add in the inflation adjustment of 1.7% = 7.90.
Beyond that, calculations are over my pay scale, but you can see that $108 looks a lot more accurate than $123.
I’m sure this is elementary but what formula did you use to get $108.34 in value for each $100 bond that investors bought in the June 19, 2014 TIPS auction? The most obvious formula I see is (1.375%/1.116%)*$100=$123.21 so I guess I’m missing something. Thanks!
YM, thank you! Correction made.
Isn’t a 13% premium = $11,300.00, not $13,000.00 (which would be a 30% premium)?