By David Enna, Tipswatch.com
The Treasury’s offering of $18 billion in a new 5-year Treasury Inflation-Protected Security — CUSIP 91282CCA7 — auctioned today with a real yield to maturity of -1.631%, the lowest real yield at auction for any TIPS in history.
But here’s the surprise: The yield was a bit higher than expected, and it seemed to indicate lukewarm demand for this 5-year offering. The bid to cover ratio was 2.5, a decent number but well below recent auctions of this term.
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.
In this case, CUSIP 91282CCA7 got a coupon rate of 0.125%, the lowest the Treasury will allow for any TIPS. And that means investors had to pay a sizable premium to collect that 0.125% coupon for 5 years, plus future inflation accruals to principal. Investors paid an adjusted price of about $109.41 for about $100.32 of value, after accrued inflation and interest are added in. This TIPS will have an inflation index of 1.00273 on the settlement date of April 30.
The Treasury’s estimate of the real yield of a full-term 5-year TIPS ended Wednesday at -1.72%, about 9 basis points below today’s result. A four-year, 6-month TIPS is currently trading on the secondary market with a real yield of -1.87%, also much lower that today’s auction result.
Nevertheless, CUSIP 91282CCA7 got the lowest auctioned real yield for any TIPS in history, surpassing the -1.575% result generated by a 4-year, 10-month TIPS reopening on Dec. 22, 2020.
Here is the trend over the last five years for the real yield of a 5-year TIPS versus the nominal yield of the 5-year Treasury note, showing how the two yields have been moving in different directions in recent months, with the nominal Treasury yield moving higher and the real yield of a TIPS moving deeply below zero.
Negative real yields are not rare for TIPS, especially for the 5-year maturity. We’ve seen them often ever since the Federal Reserve began aggressive quantitative easing programs in 2011. But today offered a first: the lowest real yield for any TIPS of any maturity at auction.
Inflation breakeven rate
With a nominal 5-year Treasury trading at 0.82% at the auction close, this new TIPS gets an 5-year inflation breakeven rate of 2.45%, a bit below the number that looked likely as trading began today. But 2.45% is still higher than the result for any recent auction for any 4- to 5-year TIPS. In fact, since 2013, only two TIPS auctions of this term have generated a breakeven rate higher than 2.0%.
Here is the trend in the 5-year inflation breakeven rate over the last 5 years, showing the immense move higher since March 2020, when the Federal Reserve and U.S. Congress began aggressive programs to stimulate the U.S. economy, with the accepted side effect of driving inflation higher:
When the inflation breakeven rate rises, TIPS get more expensive versus a nominal Treasury. Before today’s auction closed at 1 p.m. EDT, a breakeven rate of as high as 2.7% looked possible. That might have sent some investors scurrying for cover.
Reaction to the auction
Based on the 4-year, 6-month TIPS trading on the secondary market with a real yield of -1.87%, I was expecting a real yield to maturity of -1.70% or lower for this TIPS. I can understand a shorter-term TIPS getting a lower real yield right now, because investors are pricing in higher inflation for the next year, but not necessarily for the longer term.
The TIP ETF — which holds the full range of maturities of TIPS — had been trading higher this morning, and seemed unbothered by the auction result, which closed at 1 p.m. EDT. This looks like the market saw the result … and yawned.
Investors at today’s auction should welcome the higher-than-expected real yield, even if it was a record low. And keep in mind that their holding will get a 0.71% boost in principal in May, reflecting non-seasonally adjusted inflation for March 2021.
This TIPS will be reopened at auction in June, and then the Treasury will offer a new 5-year TIPS in October. Here are auction results over the last three years: