Hey TIPS fans, we’re going to close out 2014 with a very interesting auction – one that might actually be worth an investment, especially if you are looking for a short-term TIPS with a positive yield, great inflation breakeven rate and a small discount on price.
The Treasury will announce later this morning (update: here is the announcement) that it will reopen CUSIP 912828C99 on Dec. 18, creating a 4-year, 4-month Treasury Inflation-Protected Security with a coupon rate of 0.125%. Here’s what we know about that issue:
- It was first auctioned April 17, 2014 with a yield to maturity of -0.213%, requiring buyers to pay up to get the 0.125% coupon rate. The adjusted price was $101.87 for $100 of value.
- It was reopened Aug. 21, 2014 with a yield to maturity of -0.281% and an adjusted price of $103.62 per $100 of value, which included about a 1.7% bump to principal because of inflation. (Hard to remember that inflation was running higher earlier in the year.)
This TIPS is a great example of odd developments in the Treasury market in 2014. Long-term TIPS yields have fallen, but shorter-term yields have risen. I think this has happened for a couple of reasons: 1) inflation looks to be very mild over the near future, with oil prices plummeting, and 2) the Federal Reserve keeps hinting that a rise in short-term interest rates is coming in 2015.
These numbers are from the Treasury’s Real Yields Chart for 2014:
- A full-term 5-year TIPS was yielding 0.01% on Jan. 1 and yesterday closed at 0.31%, a rise of 30 basis points.
- In that same time, yield on a 10-year TIPS fell 27 basis points, from 0.74% to 0.47%.
- The yield on a 30-year TIPS fell a whopping 70 basis points, from 1.58% to 0.88%.
It’s surprising, because you’d think demand for shorter-term TIPS would be very high, given the threat of higher interest rates in the near future. But no, they are the best bargain in the TIPS world right now.
Next Thursday’s auction of CUSIP 912828C99 will create the shortest possible term (4-year, 4-months) you can get at a TIPS auction from the Treasury. And it might be sold at a small discount, in effect creating a zero-coupon note for the investor. You get a discount, collect a 0.125% coupon and then in April 2019 get back the par principal, plus inflation. What a deal.
Keep in mind, though, that this TIPS will carry about 1.5% in inflation adjustment to principal, which will wipe out the apparent discount. But you’ll get that money back in April 2019.
Here’s how CUSIP 912828C99 looks to be priced this morning:
- Bloomberg’s Current Yields page shows it trading with a yield to maturity of 0.19%. Since that is above the coupon rate, it is priced at about $99.69 per $100 of value.
- The Wall Street Journal’s Closing Prices page shows it closed yesterday with a yield of 0.158% and a price of about $99.62.
- The Treasury’s Real Yields Curve page estimates a full-term 5-year TIPS would yield 0.31%. The Treasury has been flashing some very high yields for 5-year TIPS, as high as 0.43% on Dec. 8. I generally trust these numbers, but the volatility looks suspicious.
Inflation breakeven rate. Another oddity in the TIPS market is the sharply falling inflation breakeven rates. If we go with yesterday’s Treasury numbers, a 5-year TIPS is yielding 0.31% and a 5-year Treasury is yielding 1.58%. This sets up a shockingly low inflation breakeven rate of 1.27%. If inflation averages more than 1.27% over the next five years, this TIPS will outperform a traditional Treasury.
TIPS versus traditional Treasury? Seems like a no-brainer decision. Even if this TIPS ended up under-performing, investors would lose very little. Go with the inflation protection.
A lot can happen in a week, so if you are considering an investment in this TIPS, I’d suggest waiting until closer to the auction. I’ll be checking in on it next Thursday morning, and I’ll add a link to the formal announcement when it comes later today.
Meanwhile, consider that 12 consecutive 4- to 5-year TIPS auctions have resulted in a yield negative to inflation. This one could break the string, a welcome development!
Treasury Inflation-Protected Securities 
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Mike, yeah, remember that short-term interest rates are being held very low by the Federal Reserve, very close to zero. So they offer a ‘negative real return’ … less than the rate of inflation. This will continue until the Fed allows the short-term rate to rise, and when it does it should get to at least 1.5%, maybe 2.0% or even higher.
Mike, I think the risk-free rate is usually defined as the yield on a 3-month Treasury, which is currently 0.2%, and you can find this every day on the Treasury Yield Curve site:
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
This is in a book I’m reading written by a strategic manager. “Treasury bills with 30 days to maturity are typically referred to as risk-free assets.” Now, the treasury yield curve says .02. Does that mean .02 or 2% written as a decimal?
Nevermind. It’s .02% & not 2%. The reason I am getting confused is if we use the 30 day price as the risk free asset, how does this number account for long term inflation for stocks and bonds. Seems like 2 to 5 % will be an accurate measure more than .02.
Im learning bonds and the like, but where do I find current information on the risk free rate? Will you provide a link? I know it’s the short dated bonds but what or where is that information? Thank you
I’ve been waiting a long time for TIPS with maturities under five years to have YTM’s greater than zero. Now that they have, I’m only going to purchase them if I can buy them for an inflation adjusted price at or below par. Why? Paranoia for the most part. Apparently, the Saudi’s have set their sites on trying to destroy the US shale oil and Canadian oil sands production facilities. This is exactly the sort of “black swan” event that could push the whole world into a deflationary death spiral. How does this affect the purchase of TIPS? Well, if you purchase TIPS above par and the inflation index is lower at maturity than it was at the time the bond is purchased, you are going to lose principle. The purchasing power of the money invested will remain the same. However, from a value proposition, this means you’d be better off putting the money under your mattress. So, when the 4 year 4 month re-issue comes around next Thursday, it would take an unadjusted price of $98.68 to provide an inflation adjusted price of $100. As of Saturday, the bid price on the secondary market is $99.41. So, it’s got a ways to go before I’ll find it attractive.
With the deflationary effect of lower oil prices, I’m getting a really bad feeling that the FED will use this as an excuse to indefinitely postpone any rate increases. Normally, that would cause the bond market to puke and cause the yields to plummet. But, that’s not what’s happened during the course of the last week. On 12/5, I purchased some of the bonds that mature on 4/15/19 for an unadjusted price of $99.64 (that was before I put my “bond doomsday” hat on). At that time the FVX was trading at 1.68%. A week later that same bond is being offered at $99.41. However, the FVX is trading at 1.53%. What’s up with that? It appears to me that the “smart money” is abandoning the TIPS bond market in a manner similar to what happened during the “taper tantrum”. Only this time, the prices are falling in anticipation of deflation over the short term instead of rising interest rates over the long term. The FVX is exactly were it was a year ago (1.53%). On 12/12/13 TIPS with a maturity of 4/15/18 had a YTM of -0.097. On 12/12/14, TIPS with a maturity of 4/15/19 have a YTM of +0.248. That looked good to me at first. Now, maybe not.
The market is saying that short-term TIPS are losing value due to unanticipated deflation. Basically, this is just the opposite of what makes TIPS a value proposition. It’s insurance against unanticipated inflation. TIPS maturing on 4/15/16 indicate this more forcefully. On 12/12/13, TIPS with a maturity of 4/15/16 had a YTM of -0.917. On 12/12/14, TIPS with that very same maturity have a YTM of +0.049. That’s almost a 1.0% spread for a TIPS that will mature in a little over a year. There are also some TIPS available with positive YTM’s for maturities in 2015. At first I thought that these were from individual investors in desperate need of cash. However, now I’m inclined to believe that there is some major panic selling of TIPS by institutional investors. That being said, with the paltry rates being offered on CD’s, some of these short-term TIPS may still be worthwhile purchasing. Right now, the inflation factor continues to decrease each day. This makes the TIPS you buy today have a book value less tomorrow. The gamble with these short-term TIPS is that they may not recover before the maturity date. At best, this will only return par value.
Please leave the fear mongering tactics at bay. Stick to sound evidence or at least what you think is sound evidence. No one likes a sStuart Little or a boy who cries wolf and neither are true. The law of probability says you will be right but when? Just stop
Okay. Stick to sound evidence. Thank you.
I don’t know if you were alive during the oil embargo of 1973. But, the Saudi’s were one of the principle causes of runaway inflation in 1970’s. At that time, the Saudi’s were using oil as an economic weapon against the US to punish it for support of Israel during the Yom Kippur War. Now the Saudi’s are doing the opposite. They are flooding the market with oil in an attempt to preserve their market share. The end result of this is deflationary pressures on the world economy. This is occurring at a time when the US, Europe and Japan are desperately trying to prop-up their economies by encouraging inflation. It remains to be seen what extent this reverse “oil shock” will have on the world economy. In my opinion there is strong evidence that oil price deflation is already having a visible effect on the TIPS bond market. How else to you explain bond prices going down at the same time that interest rates are declining? I feel oil deflation is the reason for the current surge in short-term bond yields. How else do you explain this sudden and drastic change?
>>>>”So, when the 4 year 4 month re-issue comes around next Thursday, it would take an unadjusted price of $98.68 to provide an inflation adjusted price of $100. “<<<<<
However, the amount of inflation adjustment is added to your principal total, so If you bought $10,000 of a TIPS with an inflation index of 1.013, your resulting principal is $10,130 on the day the auction closes. In essence you are paying $130 for $130, so not really paying up.
However, you are correct that the $130 is subject to deflation risk. If we saw five years of severe deflation (highly unlikely), you’d only get $10,000 back at maturity.