This is CUSIP 912828N71 and you can read the Treasury announcement here. It’s a new 10-year Treasury Inflation-Protected Security, and that means the both the yield to maturity (after inflation) and the coupon rate will be set by the auction.
With the stock market in turmoil so far in January, the yield on this TIPS offering is likely to be volatile. TIPS usually benefit from a flight to safety during a stock market downdraft, but that hasn’t been happening so far in 2016. Over the last five trading days, the TIP ETF has slightly lost value, while intermediate Treasuries (IEI, shown in red on the graph below) has gained 0.76%.
It’s hard to predict if this trend will continue. Here is what we know at the close of markets on Friday, Jan. 15:
- The best yield predictor for a new-issue TIPS is the Treasury’s Real Yield Curve Rates page, which estimates yields for full-term TIPS. At the close Friday, the Treasury estimated a 10-year TIPS would yield 0.67%, down just 2 basis points from where it opened the year.
- Bloomberg’s Current Yields page shows real-time numbers for the longest-term 10-year TIPS currently trading on the secondary market. Right now its yield stands at 0.64% – but this TIPS matures in July 2025, six months earlier than next week’s new issue. So its yield should be slightly lower.
- You can also look at the Wall Street Journal’s Closing Prices page and see that the TIPS maturing in July 2025 closed unchanged today with a yield of 0.628%.
So if the auction had been held today, this new 10-year TIPS probably would have yielded about 0.670%, generating a coupon rate of 0.625%. That would have been the highest yield – but just slightly – for any 9- to 10-year TIPS since July 2011.
I am especially interested in this auction because I have a TIPS – 912828ET3 – maturing Jan. 15. This was a sweetie, with a coupon rate of 2.0% and a yield of 2.025% after inflation. Inflation was a tame 19.7% over the last 10 years, but I still got about 4% annualized on that investment. (However, a nominal 10-year Treasury was yielding about 4.35% in January 2006, so it would have been the better investment.)
I have other TIPS maturing in April and July this year. At least interest rates appear to be heading higher, if haltingly. A big stock market decline could put an end to that, however.
Conclusion. I would be likely to buy this new TIPS if the yield appears to be climbing above 0.70%.
Here’s a chart of all 9- to 10-year TIPS auctions since January 2009, showing the wide variations in yield, from a high of 2.245% in January 2009 to a low of -0.750% in September 2012. It’s been an amazing seven years.
I’m new to the blog, having discovered it yesterday while pondering rolling some 1/15/27 2.375%s (with 17.8% principal accrual) in a retirement account into the new issue, thereby eliminating the accrued principal and presumably buying it at the same yield to maturity as the bonds I hold. It’s true that par guarantee is 10 years off, and I agree that while the probability of massive deflation is very low, it is not zero. I wonder if anyone has done an analysis of the market value hit (if any) on high accrual TIPs vs. low ones at same maturity. This could be an issue for someone (like me) who might sell prior to maturity.
PS- I can’t resist a hat tip to the venerable I-bond which can’t go down in value and has (after the holding period) a real put-at-par option.
@ Al in NJ:
FWIW, a TIPS expert posted the following on another blog. However, the main takeaway is that, in large part owing to the relatively poor liquidity of TIPS, which dwarfs the deflation “put”in terms of the premia, the value of the deflation put is more of an educated guess than a calculation.
“Firstly, regarding the deflation floor, allow me to preface everything below by stating that implying the price of this “put” option (and, consequently, deflation probability) from the mkt prices of TIPS is more art than science. So take whatever number I offer with a very large pinch of salt.
Here is a reasonably simple comparison of a newly issued TIPS and an aged issue (for which the cumulative deflation option is extremely far out of the money and thus almost worthless). Specifically, the floor embedded in the current 5y TIPS (0.125% coupon, 04/2020 maturity) is worth arnd 5bps. It is worth arnd 1bp for its old neighbor (1.25% coupon 07/2020 maturity, issued in Jul 2010).
I am not sure what you’d be able to do with these numbers. The issue, as I mentioned, is these calculations are reasonably tricky to perform and depend heavily on the methodology used. The resulting inaccuracies, obviously, become more significant when the options in question are worth so little”
Bob: On an aged TIPS issue, the cumulative deflation option is so far out of the money as to be almost worthless.
Bob! Excellent analysis. Here is what to consider: A new issue has no built-up inflation adjustment, but that 20-year has 19.6% of inflation adjustment, which is subject to short-term deflation, and that is looking very likely. (December inflation report comes out Wednesday.) The Treasury Real Yield estimate is currently .68% and that 2026 TIPS is yielding 0.73%. Upcoming deflation might give you an initial hit of 0.4%, but both TIPS will benefit when inflation rebounds.
Tipswatch, you say “A new issue has no built-up inflation adjustment, but that 20-year has 19.6% of inflation adjustment, which is subject to short-term deflation, and that is looking very likely.” I’m not sure, but you seem to be saying that while the existing 20-year TIPS IS subject to a short-term deflation adjustment to principal, the newly auctioned 10-year TIPS is NOT. If so, you are incorrect. BOTH will suffer the same percentage decline in principal if the CPI falls short term. For example, we know that the Reference CPI will decline 0.36% from 237.38458 on 1/29/2016 (the issue date of the new 10-year TIPS) to 236.525 on 3/1/2016 (the latest known date). (See http://eyebonds.info/tips/2016/tips00_2016.html.) The principal value of both TIPS will decline by this percent even though it means the principal of the new one will drop below 100%. The 100% minimum guarantee only applies at maturity.
Bob, totally true. However, the new TIPS can never go below par value, which was the original purchase price, so the risk is minimal, but that 20-year TIPS has a huge accumulated inflation value, all of which can be lost to inflation. I think the probability of future massive deflation is slim, but there’s the risk.
As an indicator of what the auction yield might be, I’d look at the existing 2% 20-year TIPS maturing Jan 2026 rather than the existing 0.375% 10-year TIPS maturing July 2025. The Jan 2026 is yielding about 0.1% points more than the July 2025: 0.739% instead of 0.631% according to WSJ TIPS quotes 1/19/2016,
The yield on the existing 20-year Jan 2026 probably overstates the auction yield a little because it has been outstanding for ten years and has a significant accumulated inflation adjustment. A similar situation occurs with the two TIPS maturing a year earlier: the 2.375% 20-year maturing Jan 2025 yields about 0.02% points more than the 0.25% 10-year also maturing Jan 2025: 0.702% vs 0.683%. So I’d guess the auction yield to also come in about be 0.02% points under the yield of the 20-year TIPS maturing Jan 2026.
Strong maybe on these for me. “Maybe” because there are some pretty good yielding CDs about, though a ten year maturity is pushing the envelope I’ll admit as far as safety goes. Good work!
You said: “TIPS usually benefit from a flight to safety during a stock market downdraft.” I don’t think so, and my authority for this is you. Didn’t u say just the opposite recently? It’s an important point, because the rout when Lehmann collapsed was the TIPS buying opportunity of a lifetime. Could happen again….
The Lehman moment was the crazy black swan of TIPS history. Big investors were dumping everything and deflation was a huge threat. (That was one of the few times in my life I invested in a TIPS mutual fund. Got out a year later.) TIPS and Treasurys are tied together and if nominal Treasurys see lower yields, TIPS usually follow. The other factor is Fed action to prop up the economy, If there is a threat the Fed will act, TIPS yields will plummet. So far, no indication.