I hate to be negative, but the current trend in the Treasury market has me thinking evil thoughts. Why? Yields on Treasury Inflation-Protected Securities have dropped to levels negative to inflation for maturities all the way up to 9 years. There are 39 TIPS currently trading on the secondary market, and yields are negative on 23 of them.
This is great if you own TIPS you want to trade or if you are invested in TIPS mutual funds. The value of your holdings has ‘soared’ – as much as Treasurys ever soar – in the brief time since Valentine’s Day. Here’s a chart for that time, comparing the TIP ETF, which holds the full range of TIPS, with the SPY ETF, invested in the S&P 500.
Click on image for larger version
My evil thoughts arise because I’d like to be a net buyer of TIPS, buying more than mature each year as part of a super-safe allocation in my heading-to-retirement portfolio. But right now TIPS are off the table, and I’d certainly shy away from TIPS mutual funds. And I Bonds – another trusty, super-safe investment – are about to enter a six-month period paying zero interest. Bank CDs – paying about 1% for a 1-year CD and 2.25% for a 5-year – might be a more acceptable alternative, although hardly desirable.
I’ve called TIPS the ‘Energizer Bunny’ investment in the past – they just keep going and going. Look at a 5-year TIPS. Last year’s December reopening auction resulted in a yield of 0.395%, highest in 4 1/2 years. Today, the yield on that same TIPS is -0.505%, down a shocking 90 basis points in five months. And yet the inflation index for that TIPS is .997; there has been less-than-zero inflation since this TIPS was first issued in April 2014.
Here are factors driving TIPS yields down:
- Central banks around the world are trying to inflate their currencies with asset-buying programs, resulting in 10-year bonds in Switzerland paying -0.11%; in Germany, 0.17%; in the Netherlands, 0.33%; in more-risky Portugal, 1.68%. You can get 1.88% in the non-risky United States, and that is where money is flowing.
- A crucial turning point came March 18, when Federal Reserve Chair Janet Yellen gave a decidedly wish-washy view on future short-term interest rate increases in the United States. She said: “Just because we removed the word ‘patient’ doesn’t mean we’re going to be impatient” in raising rates. The market interpreted this – correctly, I think – that the Federal Reserve lacks the courage to begin raising interest rates until inflation is above – possibly well above – its target of 2%.
- Yellen’s comments weakened the dollar, with the Euro gaining about 3% in value since her statement. It also ignited just a touch of inflation fears, which had been dormant after months of mild deflation. This makes TIPS more appealing, even at these low yields.
- If you suspect inflation will rise again to around 2%, TIPS are still the relative ‘bargain’ of the Treasury market. A 10-year TIPS currently has an inflation breakeven rate of about 1.81%. This number usually averages in the 2.0% to 2.2% range, so TIPS remain cheap against nominal Treasurys. That also increases demand.
Just as a rough guideline, I often say that TIPS mutual funds would be appealing to me when the TIP ETF reaches $110. This would happen when the 10-year yield rises to about 0.90%, a long way up from the current 0.07%.
But consider this: The TIP ETF closed at $111.51 on March 13, less than one month ago. Since then it is up 2.7%, and the Energizer Bunny dances on.
Treasury Inflation-Protected Securities 
Go to a different bank Len. I just got a medallion guarantee last week and the whole process was less than 10 minutes. Most of that was small talk then 2 minutes – maybe – of I’m doing this from here to here. Then a couple minutes of waiting for the assistant branch manager to fill in the book and sign. Pretty darn painless. And no charge.
Len, people who hold TIPS in Treasury Direct are willing to pay current-year taxes. If you want to avoid that, they must be in a tax-deferred account. Treasury Direct is definitely not for trading, I agree. If a buyer intends to trade, a tax-deferred IRA at a brokerage account is the way to go. I never trade, so Treasury Direct is fine with me.
Has nothing to do with paying current-year taxes. Tax-loss selling is to let Uncle Sam share the pain while you re-invest at a higher yield than you got on the original security. Not doing any tax-loss selling (or ever taking capital gains either) isn’t very good portfolio management if you are going out ten years or more.
“… if you have TIPS you want to trade…” May not be the appropriate place here, but I wanted to do some tax-loss selling late last year. If there is any possibility you’ll be selling securities DON”T hold them in Treasury Direct. It says on the transfer form any bank or brokerage can do the signature guarantee- they won’t unless you are a customer. I spent an entire afternoon transferring a couple TIPS and have been at the same bank ten years. After examining a print out of my Treasury Direct account, my driver’s license, my passport and checking everything but my shoe size they grudgingly agreed to do the signature guarantee. And then used the wrong stamp, causing the transfer to be rejected! I’ll be buying my TIPS at auction through Vanguard’s brokerage in the future. And they have better security too.
I’m with those who laddered my TIPS over the years and am frustrated with the yields of current bonds. As a consquence, although I have some that are maturing in a few months, I won’t purchase any to replace these.
I do have a question though. If a bond is maturing in 3 months and the YTM is negative, why shouldn’t I sell the bond and get the small return from a short-term CD or money market account?
And, why would anyone buy this bond?
Hank, I suspect the market is very think for a TIPS maturing in 3 months. Sometimes you see prices get way out of whack, partly because of the final interest payment, and partly because the annualized yield get compressed into a month or two, inflating the number. Anyway, I’d just hold it for three months, take the payout and figure out the next investment.
I generally ladder as well, but not fanatically. If the rate is sufficient to my needs I will double or triple up. Rates may be higher- or lower- next year but I’m not going to get fixated on having something come due each and every year in the future. (Joseph Murphy, With Interest, 1986). I still have thirty year Treasuries paying 7 1/2 percent from twenty years ago because of this book. (There were no TIPS back then.)
Thanks Thomas, it is a very interesting and well-written piece.
In his first post of his new blog, outgoing Fed Chairman Ben Bernanke answers: “Why are interest rates so low?”
http://www.brookings.edu/blogs/ben-bernanke/posts/2015/03/30-why-interest-rates-so-low
It is a three part series.
What a great deal for the federal government eh? Screw’em. I’m buying more short term munies and they can kiss their taxes good-bye
Let me expand on that. The Treasury manipulates their offerings to lower the government’s cost of borrowing. When rates are high they issue more short term securities and when rates are low they issue more long term debt. Obviously they also control how much is issued in the form of TIPS as well. Google: Inflation-indexed Bonds: The Dog That Didn’t Bark published by the Boston Fed for a full discussion.