The Treasury just announced that its auction of CUSIP 912828H45 – a new 10-year Treasury Inflation-Protected Security – resulted in a yield to maturity of 0.315% and a coupon rate of 0.250%.
Buyers at the auction got a much better yield than looked likely earlier Thursday, when a similar TIPS was trading on the secondary market with a yield of just 0.18%. Later in the morning, however, TIPS yields began climbing. As the auction was closing at 1 p.m., Bloomberg’s survey of dealers predicted a yield of 0.346%.
Because the Treasury sets the coupon rate one notch below the yield, buyers at today’s auction are getting this TIPS at a slight discount to par, about $99.02 per $100 of value.
Inflation breakeven rate. With the 10-year nominal Treasury currently trading at 1.89%, this TIPS is getting a breakeven rate of 1.57%, which is very low by historic standards. This indicates the markets are pricing in very low inflation over the next 10 years. Generally, a breakeven rate below 2% indicates that a 10-year TIPS is ‘cheap’ against a nominal Treasury of the same term. This rate is among the lowest seen in the last five years:
Reaction to the auction. TIPS yields were fluctuating Thursday, first dropping and then rising. After the auction, the TIP market is reacting well. This chart shows the day’s activity in the TIP ETF, which holds a broad range of maturities. It started the day up (with yields down) and then moved negative as yields rose. After the auction, the trend was back up, which usually indicates a positive reaction:
Treasury Inflation-Protected Securities 
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all financial assets appear very expensive right now.
If you’ve got enough assets to live comfortably, there’s certainly nothing wrong with having a lower withdrawal rate by investing conservatively in your retirement years. You would think that the 2008 crash would have been a wake-up call for retirement advisors. People that aren’t working can’t afford to have 30% to 40% of their assets wiped-out over the course of a year. Instead they keep espousing the same drivel about having a diversified portfolio. That strategy didn’t help much in 2008. I’ve been thru 5 of these crashes in my adult life. The first one taught me that you’re better off investing in your career than speculating in the stock market. Right now, TIPS and iBonds are basically a zero sum game. However, that’s a zero-sum game with practically zero risk.
Yes, it is really a shame. First folks got their pensions taken away and were stuck with a 401K plan instead. Now they get raped by the mutual fund companies with their promises of a happy retirement through using their “products”. If you look at the percentage devoted to stocks in their Target Date retirement funds you have to conclude they learned nothing from two crashes in a ten year span (2000 & 2008).
Well here is another way to look at low yields and their consequences. Imagine I had all my wealth in I bonds yielding 0% (plus inflation) and my brother had the standard diversified retirement portfolio. His maximum safe withdrawal rate over thirty years is 4%. And mine would be…. 3.33%.
All that risk for 67 basis points, and many states tax retirement withdrawals via income tax.. Plus it doesn’t look as though someone who retired in 2000 will be able to sustain the assumed 4% rate for their remaining 15 years due to the two crashes.
len, not exactly….4% is the minimum swr not the maximum per the bengen study at least historically. whereas 3.33 is the maximum swr from the ibond portfolio to last 30 years.
Ah, no. I have Bengen’s original study right here (1994), as well as his later renditions.
There certainly were periods when you could have withdrawn more than 4% but since you wouldn’t know that beforehand 4% is the maximum ex-ante. Wade Pfau covers it all thoroughly in his blog http://www.wpfau.blogspot.com- in fact those retiring in 2000 may not even be able to sustain 4%.
I ran simulations on the play ($1000 TIPS hedged by $500 TBT) and the results were interesting. Not terrible but not great either so I don’t plan to do it right now and would not recommend it to anyone. However when long term Treasury volatility subsides and yields start to rise with some predictability then the analysis tells me it could be a good way to buy TIPS.
Here’s what I found, starting with the happy path. If long term Treasury prices fall 10%-20% over the next year and annual average daily TLT volatility stays in its historical range (2002-present) of .5% to 1.0% then the play returns between about 3% and -3%, i.e. that’s the change in market value of the combined TBT+TIPS assets. Breakeven inflation tends to be positively correlated with nominal yield so that would likely increase the value further. May not be a great return, but the point is just to acquire TIPS without paying too much.
However if time drags on without a turnaround then the daily slippage in TBT starts bringing the pain, especially if there is high volatility. For example if nominal yields are flat over the next year and daily volatility averages only .5% then the loss is only -.9% but at 1.0% it is -3.4% and at 1.2% it is -4.8%. Not a catastrophe but not good either. That level of TLT volatility (1.2%) would exceed anything that we’ve seen in the last 13 years, but the YTD figure is .9% and if anything the market seems to be getting wilder so who knows.
Bottom line this analysis says the play is a winner if yield and inflation rise significantly within the next year or two, but any other scenario is neutral or unfavorable. Which makes it seem more like speculation than a hedge at this point, and there are probably better ways to speculate if that’s what you want to do.
BTW the results were not much different using an unlevered inverse (like TBF) vs. a levered one (like TBT) because the percent loss is smaller but you’re tying up more money ($1000 vs. $500) so it’s a wash. Also note there are different ways to model volatility which could affect the results.
John
Thx for the comments guys, much appreciated. Below are more notes on the TBT/TIPS concept. Bottom line I’m still intrigued but not yet convinced. Fortunately it’s not rocket science, and breakeven inflation is still low, so I have a window to analyze it further.
A quick look at the internet shows TBT is indeed a sore subject and a lot of people have been burned by speculating in leveraged ETF’s. However this is a hedge play not speculation so that doesn’t worry me at all.
Re Dave’s question, if both Treasuries and TIPS yields decline (or rise) without a change in breakeven inflation then the value of the TBT+TIPS package should be roughly unchanged. Most of the movements in TIPS yield are due to nominal yield changes, which tells me this play would remove most of the risk from TIPS purchase.
Re “roughly” above, there are daily slippage and tracking errors in any ETF (inverse or regular), and the more leverage the bigger the slips. Hedging is always imperfect so TBT will never exactly short TLT, let alone whatever TIPS maturities I decide to buy. For example TBT is down 44% vs. year ago and TLT is up 27%, not exactly a 2:1 ratio. My understanding is TBT slips tend to be favorable when yields rise but volatility over the period matters too. Not sure about that. I may run some simulations to get a better handle on what to expect over the next year or two.
Unfortunately I see TBT’s expense ratio is ugly .92% so that’s an issue. Also could ProShares close TBT before I’m ready to sell, and what happens then? No idea.
Finally there’s the opportunity cost of tying up money, matching each $1000 of TIPS with $500 of TBT, until I eventually trade all the TBT for TIPS and say Mission Accomplished. Right now like most people I don’t see a lot of attractive alternatives but that can always change.
Proshares TBT link below.
http://www.proshares.com/campaigns/ppc/bond_bear.html
tbt is NOT a 2x short position on tlt. inverse etfs are designed to track daily price movements. very dangerous plan in that you dont understand how inverse etfs.like tbt actually work.
John P, while I think you could have a winning strategy, the risk is also very high. What if both long-term Treasurys and TIPS both decline in yield. That is a definite possibility, given worldwide economic unease. This isn’t a great time to be accumulating a lot of TIPS, but I do think you can be selective, buy them at auction, don’t overthink it. Look for good yields. I have no idea where yields are heading, and last week I proved I couldn’t even predict 4 hours into the future. The market can move against you. Use TIPS as a safe investment, with zero risk. That means buy and hold to maturity. Very boring. Little potential to make you rich. Zero potential to lose money. Then, in the rest of your portfolio, accept a little risk, but not crazy risk.
Correction I meant TBT (short Treasury) not TLT (long Treasury), sorry about that.
My situation is I don’t currently have any TIPS and would like to build a ladder for the usual reasons: Super safe part of the portfolio, government backed inflation protection in the retirement years. I expect the US will eventually return to historical yield and inflation rates like 4% and 2% or higher in our lifetimes and want to be protected against that (esp. the “or higher” part). So in terms of goals and assumptions, I think I’m probably the average TIPS investor. I’m just new to the party. For us newbies the problem is high prices so that’s why I’m looking for an end run.
I agree TLT alone would be risky, but as a hedge to TIPS it seems OK. Short (TLT) and long (TIPS) cancel so nominal yield is in effect taken out of the equation. So in that sense the play is actually reducing risk, or maybe technically that’s uncertainty. Anyway with nominal yield out of the way, it’s one less thing to worry about. The pivot just becomes expected inflation. A while back you mentioned an ETF (no longer in business) which was based on the TIPS breakeven inflation rate. I think this play is essentially a DIY version of same thing.
I haven’t pulled the trigger yet for a couple of reasons. One is confidence, because this seems obvious but I don’t know anybody doing it, which in finance is usually a bad combination. As my econ prof said “the greatest risk is when you start believing your own stuff”. Second I haven’t really investigated TLT in terms of expense overhead, insolvency risk, etc. Obviously until you reach the end zone and convert all those appreciated TLT shares to TIPS, it isn’t Treasury solid.
The advice of professors is, sadly, under-rated! 15 years ago one noted in the Wall Street Journal that TIPS and I bonds were then yielding about 4%. The usual inflation-adjusted withdrawal for a 30 year retirement from a diversified portfolio of stocks, bonds, cash, and REITS is….. 4%. So why weren’t people buying the Treasuries so they could spend 4% annually and still have their original (inflation-adjusted) capital in the end? Best advice I ever got anywhere! I did.
Len, I was a buyer, too, back in the late 1990s. TIPS weren’t even on the radar for most investors. We were getting a 3.5% to 4% real return, which is astounding. What I didn’t realize is that it wouldn’t last. Eventually 2% became the norm, then lower, and lower, and lower. Anyway, I still own a couple of the 30-year issues, which help my overall return.
John, your strategy sounds OK, but I think going 2x short long-term Treasurys is very risky, and that’s not my investing style. TLT (the regular long-term bond ETF) is very volatile, up 27% in 2014, but down 21.8% in 2009. TBT was down 41.3% in 2014. Eventually, going short on TLT will pay off very big, but the bond market is too unpredictable, at least for me. I just view TIPS as an investment in my super-safe allocation of my portfolio, like bank CDs and I Bonds.
I too would say be very cautious. In the past when I tried to be clever I frequently found myself blind-sided by the unforeseen. Since I retired I’ve become much less adventurous and why not? Big losses would be more harmful than big gains would be helpful. It was by being conservative that I pulled the plug at 50 to begin with.
For somebody wanting to buy TIPS now but daunted by the high prices, what about simultaneously shorting nominal long term Treasury bonds? The idea being to obtain the TIPS attributes that we like (inflation protection & government backing) even if/when nominal yields rise as most people expect they certainly eventually will. For example I see an ETF called TBT which “seeks daily investment results that correspond to two times the inverse (-2x) of the daily performance of the Barclays U.S. 20+ Year Treasury Bond Index”. Which presumably explains its terrible recent performance down 50% last year and 80% last 5 years. The tactic would be to hedge every $1000 of long term TIPS purchase with $500 of TBT. Then when nominal yields and inflation return to normal historical levels, trade the ETF for more TIPs bonds. This would be simple to execute within my IRA.
Seems pretty attractive am I missing something? Maybe risk or inefficiency in the ETF?
Cheers,
John
I bought some of this issue. Nowadays TIPS/Treasuries are not getting much “love.” The brokerage was trying to talk me out of this and said regular treasuries are a better deal, but even those are pretty bad now. They are trying to push me into equities for long-term investments.
Len, but there currently is some amount of manipulation of interest rates, keeping them artificially low, since even short term rates should be at or above the inflation rate. First the Fed with multi-year bond-buying, and now the Europeans, which increases demand for higher-yielding US debt, and that again forces interest rates lower. It probably won’t end anytime soon.
Well the Fed’s primary influence is at the short end of the curve, except for recently of course. In any event if I have no way of knowing ahead of time what their moves might be, discounting Wall Street babble, then it is random for me. When people delay buying in hopes of some future, higher yield they rarely calculate the interest they have lost by waiting. I don’t know what the Fed will do in the future and if they are responding to conditions then, neither do they. Or so I see it.
no reason at all that short rates.should be at or above inflation rate but even if its true, we seem to be in a generally deflationary world. the only real issue is what rate does the best job of maximizing real economic output while avoiding excessive risk of depression recession mass unemployment or excessive.inflation? the fed thinks 2% inflation would be just right but its difficult to.calibrate because of.what is happening in global markets. the price of.tips is being arbitraged by global markets against all other financial assets. if they seem too expensive its because of a very high demand for them which signals fear. if you feel the fear unjustified then obviously lessen allocation to them.
In thirty years I have had very little success at predicting interest rates. I have watched quite a few others say “Too low, I’ll wait until rates go up!” and then rates decreased even further for a while.
If you are mathematical: The Random Character of Interest Rates by Joseph E. Murphy
If you are not then: With Interest by Joseph E. Murphy (Same material simplified)
Convinced me not to put any money on my guesses, though they are still fun to make.
The quote is “It’s tough to make predictions, especially about the future.” I passed on this auction. A month ago, the five-year re-issue had a with a YTM of .395%. A ten-year with a yield of .315% looks like a real stinker in comparison (even though the coupon is a whopping .250%). Last year, the same maturity has a “lofty” YTM of .661% However, the only other thing out there with a maturity under ten years with an inflation adjusted price under par is the 7/15/24 TIPS at $98.90 with a YTM of .200%. Four months ago, that 7/15/24 TIPS was going for an inflation adjusted price of $96.25 with a YTM of .547%. The TIPS market went from hopeful a year ago to interesting a month ago to absolutely pathetic. To quote Yogi again. “The future ain’t what it used to be.”
Len, congrats on the yield. I have gotten a lot better at making predictions – I do call them ‘guesses’ – but I staked out a guess too early today, right after the market opened. A lot changed as the morning continued. Funny thing that the big dealers overshot on the high side in the Bloomberg estimate, which comes out 1 p.m., almost exactly when the auction is closing.
A pleasant surprise to be sure and it puts me in mind of the Yogi Berra quote, which I can’t remember but relates to making predictions. Not the first time this has happened of course, where the pre-auction rate looked pretty dismal but turned out acceptable. I myself have given up holding off to see if a re-opening might be a better deal.