By David Enna, Tipswatch.com

The U.S. Treasury’s offering of $15 billion in a reopened 5-year Treasury Inflation-Protected Security was met with apparant strong demand today, producing a real yield to maturity of -1.58%, the lowest in history for TIPS auctions of this term.

This was CUSIP 91282CAQ4, in a 4-year, 10-month version. It 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.

The auction yield of -1.575% set a record for the lowest in the history of 4- to 5-year TIPS auctions, dipping below the previous record of -1.496% set in an auction in December 2012.

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.

So in Tuesday’s auction, investors had to pay a sizable premium above par value because the auctioned real yield of -1.575% was well below the coupon rate of 0.125%. The adjusted price was $108.87 for about $100.37 of value, after accrued inflation and interest is added in.

Negative real yields on TIPS haven’t been unusual since 2011, when the Federal Reserve began its aggressive quantitative easing programs. Another phase of QE started in March 2020, as the global pandemic set off chaos in the bond market. TIPS yields are likely to remain negative to inflation through 2021, and possibly beyond. Here’s a look at 5-year real yields going back to January 2003:

Inflation breakeven rate

With a 5-year Treasury note trading today with a nominal yield of 0.37%, this TIPS gets an inflation breakeven rate of 1.94%, the highest for any auction of this term since August 2018. It means this TIPS will outperform a nominal Treasury of the same term if inflation averages more than 1.94% over the next 4 years, 10 months. It also indicates that TIPS are getting more expensive versus nominal Treasurys.

In “normal” times, a TIPS would be likely to carry an inflation breakeven rate of 2%, or even a bit higher. But over the last decade, inflation has been averaging solidly lower than 2% — it is currently running at 1.2% has averaged 1.7% over the last 10 years.

Here is the trend in the 5-year inflation breakeven rate back to 2003, showing that the current rate is now at a level that is historically typical, despite a decade of lower-than-expected inflation.

Reaction to the auction

It appears that this auction was met with solid demand. The real yield dipped a couple basis points lower than where this TIPS started the day on the secondary market. The auction had a bid-to-cover ratio of 2.86, indicating solid demand.

This auction closes the book on the unattractive history of CUSIP 91282CAQ4:

The Treasury will offer a new 10-year TIPS at auction on Jan. 21, 2021.

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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.