The ‘bond bubble’ didn’t burst in 2015, but it did fizzle a little. Vanguard’s Total Bond Market ETF (BND) started the year at $82.65 and ended at $80.76, a decline of 2.3%. But when you add in dividends the fund paid, it eked out a tiny positive return for the year.
TIPS didn’t fare as well, as inflation breakeven rates fell to extremely low levels against traditional Treasurys. That indicates investors are shunning TIPS, causing yields to rise. The broadly diversified TIPS ETF (TIP) started the year at $112.73 and ended at $109.68, a decline of 2.7%. The fund’s total return after distributions was -1.75%.
At the end of the year, the TIP ETF finally fell below the $110 level, which I have been predicting would be a positive indicator for buy-and-hold-to-maturity TIPS investors. It was as high as $123.15 in December 2012.
What does it mean? The TIPS market is a lot more attractive going into 2016 than it has been for nearly five years. Here’s a rundown of all the TIPS auctions of 2015:
CUSIP 912828H45: 10-year TIPS
First auction, Jan. 22: Auctioned with a yield to maturity (after inflation) of 0.315% and a coupon rate of 0.250%. The inflation breakeven rate was 1.57%.
Reopened, March 19: Auctioned with a real yield to maturity of 0.2%, the lowest yield for an 9- to 10-year TIPS at auction since May 2013. The inflation breakeven rate rose to 1.77%. The auction was a bit of a disappointment, coming one day after Fed chair Janet Yellen declared the Fed would move slowly on increasing short-term interest rates.
Reopened, May 21: Auctioned with a real yield to maturity of 0.358%. The inflation breakeven rate was 1.852%.
CUSIP 912810RL4: 30-year TIPS
First auction, Feb. 19: Auctioned with a coupon rate of 0.750% and a yield to maturity of 0.842%. This was the lowest yield for any 29- to 30-year TIPS auction since February 2013, and the yield of 0.842% was far below the previous year’s 30-year TIPS, which auctioned on Feb. 20, 2014, with a yield of 1.495% and a coupon rate of 1.375%. In my preview article on this auction, I cautioned against this auction, which I predicted could be a ‘time bomb.’
Reopened, June 18. Auctioned with a real yield to maturity of 1.142%. The unadjusted price was $90.16 for $100 of value, because the yield was much higher than the 0.750% coupon rate. This TIPS lost nearly 10% of its value in four months.
Reopened, Oct. 22. Auctioned with a real yield to maturity of 1.20% and an unadjusted price of $88.91 for $100 of value. The inflation breakeven rate was 1.66%, ultra-low for a 30-year issue.
CUSIP 912828K33, 5-year TIPS
First auction, April 23: Auctioned with a real yield to maturity of -0.335%. The coupon rate was set at 0.125%, the lowest the Treasury allows on a TIPS. This is the lowest yield for any 4- to 5-year TIPS at auction since Dec. 19, 2013. In my preview article, I suggested that investors ‘look for better alternatives.’
Reopened, Aug. 20: Auctioned with a real yield to maturity of 0.305%, a huge jump – 64 basis points – over the April 23 original auction. The unadjusted price was $99.17 for $100 of value and the inflation breakeven rate was a remarkably low 1.16%. In my preview article, I noted this auction was ‘a lot more attractive‘ than April’s. I was a buyer.
Reopened, Dec. 17: Auctioned with real yield of 0.472%, the highest for any 4- to 5- year TIPS auction since April 2010. The unadjusted price dropped to $98.52 for $100 of value and the inflation breakeven rate rose to 1.25%. I was a buyer.
CUSIP 912828XL9, 10-year TIPS
First auction, July 23: Auctioned with a coupon rate of 0.375% and a real yield to maturity of 0.491%. The unadjusted price was $98.87 per $100 of value, and the inflation-breakeven rate was 1.79%.
Reopened, Sept. 18: Auctioned with a real yield to maturity of 0.60% and an unadjusted price of $97.86 for $100 of value. The yield of 0.60% was the highest for any 9- to 10- year TIPS since an auction in September 2014. The inflation breakeven point dropped to 1.56%. I was a buyer.
Reopened, Nov. 19: Auctioned with a real yield to maturity was 0.664%, just barely beating a couple of 2014 auctions to become the highest yield for any 9- to 10-year TIPS auction since May 2011. The unadjusted price was $97.31 per $100, and the inflation breakeven rate was 1.60%.
The trend in inflation
‘Headline’ inflation has remained stubbornly low, held down by a collapse in gasoline prices in 2014. As of November, 12-month inflation was running at 0.5%, but core inflation – which strips out energy and food – has climbed to 2.0% over the last 12 moths. If energy prices rise or even stabilize, we could see higher headline inflation in 2016. Here is the trend over the last year:
Here’s a little more info on the tax issue. You can ignore the mentions about 2015. It’s really about 2016 for TIPS. As I noted, TIPS have become subject to this for the first time in 2016 — ie., it won’t effect your TY2015 info/1099. But you may need to make an election by 12/31/2016 after consulting with your tax lawyer/CPA.
“Bond Premium Amortization Update
It is important that you advise your bond-holding clients to contact their brokers by the end of December to request that bond premiums be amortized on all taxable bonds for their 2015 information returns. A less advantageous compliance alternative would be to inform the broker that you do not wish to amortize premiums on any bonds. The 2014 Form 1099-INT instructions and temporary regulations under Section 1.6049-9T require brokers to make inconsistent assumptions for “noncovered” and “covered” bonds, which may result in inadvertent noncompliance. (In general, covered bonds are those that were acquired after 2013 and that are covered by the broker basis reporting rules as described in Reg. Section 1.6045-1(a)(15)(i)). In the past, few taxpayers elected to amortize taxable bond premiums under IRC Section 171 because the information for making the election was not readily available. New rules released in March generally require brokers to report taxable bond interest and the basis on covered taxable bonds as if the election had been made. Some brokers have implemented the rules earlier than required, which may cause some erroneous basis computations. Taxpayers and return preparers should carefully review the basis computations to ensure they reflect only amortization actually taken. While the amortization election is generally advantageous to taxpayers, it must apply to all taxable bonds, including any noncovered bonds in the taxpayer’s portfolio. This inconsistent 1099 treatment can cause a possible invalid election and mismatching of both interest income and basis reported on tax returns versus Forms 1099. TSCPA’s Federal Tax Policy Committee commented to the Treasury on this issue, but the comments were not heeded.
– See more at: http://tscpafederal.typepad.com/blog/2015/12/bond-premium-amortization-update.html#sthash.0LQugn6O.dpuf “
David, I would like to thank you for maintaining this blog. I am a do-it-yourself investor and I’ve been following your blog for a little more than a year now I believe. The insights, historical perspective and suggestions you provide are extremely helpful. I’ve been wanting to purchase TIPS for some time, but have held off given the very low (even negative) yields. This year I made my first two purchases: 10-year TIPS at the July 23rd auction and 5-year TIPS at the Dec 17th auction. I can only imagine how much work it is to maintain this blog – it has made a real difference for me giving me the confidence to make these purchases. Jim
James, I appreciate your kind words. You made some good purchases in 2015, I bought both of those TIPS too, although I did the 1st reopening on the 10-year. I have been buying very little in the last four years. I think we are heading into a better period. If you buy and hold to maturity, you should do fine.
Daniel, no I won’t be buying I Bonds in January. Might as well wait to April to see how interest rates develop. The fixed rate could rise. The inflation-adjusted rate isn’t looking too promising so far, but who knows. I might end up waiting until November.
Will you purchase your 2016 I-bonds right away? Or will you wait until mid April when you will know what the next half-year’s interest rate will be, and maybe wait until November if there is another zero interest half year (May-October)?
Just a note for those buying TIPS outside of a retirement account this year. TIPS purchased after Jan 1 2016 are now “covered” securities, which has significant 1099 and tax reporting implications. If you depart from Vanguard’s (or your brokers’) default elections for reporting either bond market premium or market discount interest on your taxes, you will need to inform them in writing, or the basis they report could be incorrect. Personally, between the OID, the treatment of non-covered TIPS (purchased before 1/1/206) I find it all pretty confusing, and am thinking it might be better for me to give up on individual TIPS and just buy TIPS funds or ETFs from now on, because they don’t have this issue.. However, if anyone out there is a tax maven, I’d appreciate any advice you can give me at to what election people should make on newly purchased TIPS. Theoretically, it is tax advantaged to report bond market premium annually (it is set-off against OID and coupon interest). But the problem is I, like virtually every other small investor, didn’t even know you could do this until last year,, when it appeared as box 11 on 1099-INTs for the first time, so my previously purchased bonds have not been amortized. What implications will making an election have at this point? Here is the link to the Vanguard pdf. https://personal.vanguard.com/pdf/isficb.pdf Every time I read it i get more confused, which isn’t necessarily Vanguard’s fault. However, as of yet, the customer service folks don’t really have a lot of answers (and can’t give tax advice in any event). My greatest concern is whether the Vanguard system is set up to get the basis correct when there are so many different permutations and elections to be made. (Good luck trying to calculate the basis yourself.)