By David Enna, Tipswatch.com
The U.S. Treasury will offer $13 billion in a March 18 auction reopening CUSIP 91282CBF7, creating a 9-year, 10-month Treasury Inflation-Protected Security. Real yields have been climbing recently, but are yields up enough to make this reopening an attractive investment?
I plan to take a look, but first …
Let’s look back one year
Thursday’s auction will mark the one-year anniversary of the strangest TIPS auction in history — March 19, 2020 — which came just as awareness of the COVID-19 pandemic was exploding across the United States. This was a reopening auction offering $12 billion in CUSIP 912828Z37, also a 9-year, 10-month TIPS.
At the time, the Federal Reserve had already begun lowering its key short-term interest rate and had announced plans for a launch of a new quantitative easing program to hold down Treasury yields. By any indication, Treasury yields across the board should have been plummeting. But instead, for a brief few days, the bond market was seized by near panic and Treasury yields skyrocketed.
The Saturday before this TIPS auction, when its real yield had climbed to 0.04% on the secondary market, I noted in my preview article:
“The U.S. stock and bond markets are covered in fog this morning. Investors are up in the air and it’s not safe for landing. …
In past times when the U.S. economy sank into distress, the Federal Reserve launched bond-buying programs that propped up U.S. Treasury prices, and sent yields plummeting. … So for a TIPS trader, there is potential for a quick capital gain if the 10-year TIPS yield falls 50 basis points or more, just to the level where it was (-0.57%) on March 6. …
“What about buy-and-hold TIPS investors? A real yield of around zero isn’t attractive, but it might be the best yield you’ll get for the remainder of 2020.”
Less than a week later, CUSIP 912828Z37 reopened at auction with a real yield of 0.680%, a mind-boggling explosion of 125 basis points in just 13 days. I called it a “gorgeous result” for investors. This surge in real yields happened very quickly, practically a matter of hours.
I didn’t end up buying that TIPS because I didn’t trust that the surging yield could hold through an auction. Instead, when I saw the TIP ETF drop to below $110 a share on March 18, I jumped in with an investment in Schwab’s ETF, SCHP. I sold it 40 days later for an 11% gain. (Reminder: I’m not a TIPS trader! But this was a very weird market moment.)
In the weeks and months after that auction on March 19, 2020, 10-year TIPS real yields did plummet, down to -0.25% by March 30, and eventually down to -1.08% on Jan. 4, 2021. And then a gradual rise began, spurred by positive trends in the U.S. economy.
Here is the trend in 10-year real yields over the last five years, showing the very brief spike higher than happened to coincide with the TIPS auction on March 19, 2020, and then the very sudden drop deeply negative to inflation:
So now, back to the present
Real and nominal yields have been climbing recently, reflecting positive U.S. trends toward limiting the effects of the COVID-19 virus and aggressive stimulus programs launched by Congress. The Treasury’s estimate of the real yield of a 10-year TIPS has increased from -1.06% on Jan. 28 to -0.62% as of the market’s close on March 12. That’s a jump of 44 basis points, and that’s significant.
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 inflation.
CUSIP 91282CBF7, which is being reopened Thursday, currently trades on the secondary market and you can track its real yield in real time on Bloomberg’s Current Yields page. As of Friday’s market close, it was trading with a real yield to maturity of -0.65% and a cost of about $107.94 for $100 of par value. It is trading at a premium to par because the real yield of -0.65% is far below the coupon rate of 0.125%.
In addition, it will carry an inflation index of 1.00473 on the settlement date of March 21. This means that investors seeking to buy $10,000 in this TIPS will pay about $10,845 for about $10,047 of value, after the rate premium and accrued inflation are added in. (This could change before Thursday’s auction, of course.)
Inflation breakeven rate
With a nominal 10-year Treasury note currently yielding 1.62%, this TIPS as of Friday’s market close has an inflation breakeven rate of 2.27%, rather high, even by historical standards. It means this TIPS will out-perform a nominal Treasury if inflation averages more than 2.27% over the next 10 years. U.S. inflation is currently running at 1.7% and has averaged 1.7% over the last 10 years. So investors are bidding up TIPS prices in anticipation of higher future inflation.
I agree that higher U.S. inflation seems likely, but 2.27% over the next 10 years might be about right. At the best, this TIPS is fairly priced versus a nominal U.S. Treasury, and and the worst, it’s overpriced. It’s definitely not cheap.
Here is the trend in 10-year inflation breakeven rate over the last 5 years, showing the impressive move higher since the extremely negative outlook of March 2020. This chart clearly shows inflation expectations are at the highest levels of recent years:
Disclosure: I’m biased
I’m not buying TIPS in this current market, with yields deeply negative to inflation. I’d get interested in investing in 10-year TIPS when the real yield can at least rise higher than the 0.0% real yield offered by a U.S. Series I Savings Bond.
But that doesn’t mean TIPS are lousy investments, especially for buy-and-hold-to-maturity investors building multi-year ladders for future retirement income. If you are buying a consistent amount each year, adding a year 10 years out to the ladder, Thursday’s auction certainly looks a lot more attractive than 91282CBF7’s originating auction on Jan. 21, which generated a real yield of -0.987%, the lowest in history for 9- to 10-year TIPS auctions.
I will be posting the auction results soon after it closes at 1 p.m. EDT Thursday. Non-competitive bids need to be made before noon Thursday.
Here’s a history of recent 9- to 10-year TIPS auction, with the “gorgeous result” of March 19, 2020 highlighted:
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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 discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Thursday morning update: A fast-rising 10-year nominal Treasury (now up to 1.73% this morning) is dragging the 10-year real yield higher, now up to -0.59% just hours before the auction. That adds up to a inflation breakeven of 2.32% as the market expects higher inflation for a longer time.
Tuesday update: The market closed today with CUSIP 91282CBF7 trading with a real yield to maturity of -0.69% and a price of about $108.29 for $100 of par value. That means yields have been slipping lower so far this week, and the resulting price for investors has been rising.
Thanks for posting this. I had thought that these would be good given the rising yields. What are your thoughts on buying 30-year bonds or something like TLT/SCHQ/GOVZ at this time?
Long-term Treasurys are risky right now because we are in an uncertain economic transition. If the economy tanks, and the stock market plummets, long-term Treasurys will do very well. If the economy soars, and long-term interest rates climb, long-term Treasurys could be a disaster. I have no idea of where we are heading.