By David Enna, Tipswatch.com
TIPS auctions are almost always on a Thursday, but that won’t happen next week, because Thursday is Christmas Eve, which this year only is a federal holiday thanks to an executive order by President Trump.
So the U.S. Treasury will instead stage its reopening auction for $15 billion of CUSIP 91282CAQ4 on Tuesday, Dec. 22, creating a 4-year, 10-month TIPS. This TIPS was born in an originating auction on Oct. 22, when it generated a real yield to maturity of -1.32%. The coupon rate was set at 0.125%, the lowest the Treasury will go for any TIPS.
A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So, the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or below) inflation. The price of a TIPS is adjusted to reflect how much the real yield is above or below the coupon rate.
In the originating auction on Oct. 22, investors had to pay a large premium to collect the coupon rate of 0.125%. The adjusted price was about $107.59 for about $100.20 of value, after accrued inflation and interest are added in.
Next week’s auction is likely to carry an even higher premium price. This TIPS trades on the secondary market, so you can track its real yield and price on Bloomberg’s Current Yields page, which updates in real time when the market is open. As of about 10:20 a.m. today, this TIPS had a real yield to maturity of -1.58% and a price of about $108.58 for $100 of par value.
If that price holds through Tuesday’s auction, it will be the lowest real yield ever recorded in a 4- to 5-year TIPS auction. The current record is -1.496% from a reopening auction on Dec. 20, 2012. Just a year ago, on Dec. 19, 2019, a TIPS reopening of the same term got a real yield of 0.02%, a remarkable 160 basis points higher than the current yield for the same term of TIPS.
(In addition, this TIPS will carry an inflation index of 1.00352 on the settlement date of Dec. 31, so investors will pay a slightly higher price and receive a matching amount of additional principal.)
Here is the trend in 5-year real yields over the last five years, showing the deep drop in yield after the Federal Reserve began lowering interest rates and buying Treasury securities amid the pandemic panic of mid-March 2020:
Inflation breakeven rate
With a 5-year nominal Treasury note now trading with a real yield of 0.35%, this TIPS currently has an inflation breakeven rate of 1.94%, a bit higher than recent trends. This indicates that investors are now anticipating higher future inflation. (U.S. inflation is currently running at 1.2% and has averaged 1.7% over the last five years.) Inflation will have to average higher than 1.58% for investors to get any nominal return at all from this TIPS.
A higher inflation breakeven rate indicates that a TIPS is getting more expensive versus a nominal Treasury of the same term. The best you could say is that this TIPS is now “fairly priced”; it certainly isn’t cheap.
Here is the trend in the 5-year inflation breakeven rate over the last five years, showing the steep climb higher after the Federal Reserve stepped into Treasury markets in mid-March:
The obvious alternatives
This 5-year TIPS is looking highly unattractive, possibly setting a record low yield and carrying a very high premium price (likely around 8% above par) for a 0.125% coupon rate, plus inflation adjustments. One good thing, though, is that the term is only 4 years, 10 months, the shortest term currently offered in TIPS auctions.
Series I Savings Bond. I Bonds currently offer a real yield of 0.0%; in other words they will exactly match future inflation with no risk of loss during deflationary periods. This means the the I Bond has a 158-basis-point advantage over this offering of a TIPS reopening. I Bonds have zero duration risk, and can be redeemed after 1 year with a small penalty and after 5 years with no penalty. But … purchases are limited to $10,000 per person per calendar year. It takes multi-year effort to build up an asset allocation in I Bonds.
Even if you have already purchased up to the limit in 2020, in January you get a new purchase cap and can again invest in I Bonds up to the cap. I Bonds are the best inflation-protected investment right now.
5-year bank CD. Best-in-nation 5-year bank CDs are currently offering insured nominal yields around 0.90%, which boost the inflation breakeven rate of this TIPS to a daunting 2.48%. Think inflation will average higher than 2.5% over the next five years? But the TIPS. Think it will be lower? Buy the 5-year bank CD.
I think most people, though, would opt for a shorter-term CD. Best-in-nation one-year bank CDs currently have nominal yields around 0.6%. That’s lousy, but safe and will beat your money market’s return of around 0.05%.
Tuesday’s auction will operate on the normal schedule, with noncompetitive bids due by noon EST and the auction will close at 1 p.m. I hope to post the results soon after the auction’s close.
Here is a history of all 4- to 5-year TIPS auctions back to 2012:
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.