By David Enna, Tipswatch.com
The U.S. Treasury on Thursday (Feb. 18, 2021) will auction $9 billion in a new 30-year TIPS, CUSIP 912810SV1. The coupon rate and real yield to maturity will be set by the auction results, but a couple things are nearly certain: 1) The coupon rate will be set at a record-low 0.125%, and 2) the real yield to maturity is likely to be negative to inflation.
Because my style of investing in TIPS is to buy and hold them to maturity, a 30-year TIPS has zero appeal for me. I have invested in them in the past, with maturities in 2029 (3.875% coupon rate) and 2041 (2.125% coupon rate). Those remain outstanding investments, but now that the new-issue maturity date has stretched out beyond my likely lifespan — 2051 — and real yields have dropped to negative levels, a 30-year TIPS doesn’t interest me.
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 U.S. Treasury is currently estimating the real yield of a full-term 30-year TIPS at -0.16%, which means an investor is willing to accept a return 0.16% less than official U.S. inflation over the next 30 years. That yield estimate has actually been rising recently, coming off a 2021 low of -0.39% on Jan. 4.
The lowest auctioned real yield for any 29- to 30-year TIPS was set last year, on Aug. 20, when a 29-year, 6-month TIPS got a real yield of -0.272%. That is the only auction of this term to ever get a negative real yield.
If Thursday’s auction result sets the real yield in the negative range, the Treasury will set the coupon rate of this TIPS at 0.125%, and investors will have to pay a premium, probably about $108.50 (or more) for $100 of par value in this TIPS.
To summarize, then, an investor interested in purchasing $10,000 of this TIPS will have to make an initial investment of about $10,850, and then will receive about $12.50 in interest payments a year, rising with inflation. The principal balance will also rise with inflation, for 30 years. The accrued principal (which is taxable in the current year it is accrued) can’t be touched until the TIPS matures or is sold. This is the reason a TIPS of this term, with this low a yield, should only be purchased in a tax deferred account.
Here is the trend over the last 5 years in the 30-year real yield, showing the dramatic drop in after-inflation returns since early 2019, and the dip into negative yields after the Federal Reserve began its bond-buying stimulus program in March:
30-year TIPS as trading investment
Because 30-year Treasurys (bonds or TIPS) are so volatile, many investors find them appealing for short-term trades. For example, a new 30-year TIPS issued a year ago, on Feb. 20, 2020, got a real yield of just 0.261% and a coupon rate of 0.250%, both of which look unattractive. But that TIPS — which auctioned with an adjusted price of about $99.64 — is now trading on the secondary market at $112.46, a gain of 12.5% in a year.
A small swing in yield for a 30-year Treasury can generate a large gain or loss in the short term. Traders just need to understand the risk. It’s not my thing. I have no opinion.
30-year inflation breakeven rate
With a 30-year Treasury bond trading with a nominal yield of 2.01%, this TIPS would get an inflation breakeven rate of 2.17% if it auctions with a real yield of -0.16%. That would be the highest breakeven rate for any auction of this term since October 2013, but breakevens were also near this level in 2018. A higher inflation breakeven rate indicates that a TIPS is becoming more “expensive” versus a nominal Treasury of the same term.
Here is the trend in the 30-year inflation breakeven rate over the last 5 years, showing the very strong rise in inflation expectations since the worst days of the pandemic in March 2020:
The obvious alternative: U.S. Series I Savings Bonds
Another Treasury issue, the U.S. Series I Savings Bond, also adjusts to official U.S. inflation but currently has a real yield of 0.0%, which is 16 basis points higher than a 30-year TIPS. (That spread is equal to nearly 5% in current value.) But the I Bond has other significant advantages: 1) a flexible maturity date of 1 year with a small penalty, or 5 to 30 years with no penalty, 2) tax-deferred interest payments, and 3) much better protection against future deflation.
When a 30-year TIPS has a negative real yield, the I Bond is a superior investment. Purchases are limited, however, to $10,000 per person per calendar year.
The Feb. 18 auction
Noncompetitive bids (like those made at a brokerage or Treasury Direct) close at noon on Feb. 18, and the auction ends at 1 p.m. I will be posting the results Thursday after the close.
Here’s a history of recent TIPS auctions of this term: