Hint: It won’t be a thing of beauty. But investors may snatch it up.
By David Enna, Tipswatch.com
The U.S. Treasury on Thursday will offer $16 billion in a new 10-year Treasury Inflation-Protected Security, CUSIP 91282CCM1. The coupon rate and real yield to maturity will be determined by the auction result.
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 in this case, below) inflation.
This is a new TIPS, and auction results for new issues can be a little more complicated to predict. After all, there will be $16 billion in new supply entering the market. And these TIPS auction amounts have been inching higher as the Treasury requires more borrowing to finance ever-larger U.S. deficits. Here are auction amounts for recent new 10-year issues:
- July 22, 2021: $16 billion
- Jan. 21, 2021: $15 billion
- July 23, 2020: $14 billion
- Jan. 23, 2020: $14 billion
- July 18, 2019: $14 billion
- Jan. 17, 2019: $13 billion
In less than three years, the 10-year auction amounts have increased 23%. At some point, will the offering size grow too large for demand? That’s not likely for now, as the Federal Reserve continues aggressively buying TIPS and other U.S. Treasurys, keeping yields under control.
One thing about Thursday’s auction is certain: The Treasury will set the coupon rate for this TIPS at 0.125%, the lowest it will go for any TIPS.
As of Friday’s market close, the Treasury, on its Real Yields Curve page, was estimating that a full-term 10-year TIPS would have a real yield of -1.02%. That estimate has dropped 15 basis points since July 1. So the yield trend is working against potential investors in this TIPS. And that deeply negative yield — much lower than the coupon rate of 0.125% — will make this TIPS pricey. The adjusted auction price will probably be about $112 for about $100.39 of value, after accrued inflation is added in.
This TIPS will have an inflation index of 1.00387 on the settlement date of July 30. That number, by the way, is a reflection of the extraordinarily high non-seasonally adjusted inflation of 0.80% in May 2021. One month later, in August, the principal balance of this TIPS will adjust 0.93% higher, matching non-seasonally adjusted inflation in June. This two-month inflation trend definitely adds to the appeal of this TIPS.
If CUSIP 91282CCM1 does auction with a real yield to maturity of -1.02%, it will be the lowest yield ever for any 9- to 10-year TIPS auction. The current record low of -0.987% was set in a January 2021 auction.
Here is the trend in 10-year real yields over the last five years, showing the deep decline in the period after March 2020, when the COVID-19 pandemic began exploding across the United States. In mid-March, the Federal Reserve began an aggressive program of bond-buying, which has kept both real and nominal yields at extremely low levels.
Inflation breakeven rate
The Treasury is currently estimating the nominal yield of a full-term 10-year Treasury note at 1.31%, which means that if CUSIP 91282CCM1 auctions with a yield of -1.02%, it will get an inflation breakeven rate of 2.33%. That is well off recent highs for this metric, which hit a one-year high of 2.54% on May 17.
A lower inflation breakeven rate makes this TIPS more attractive versus its nominal alternative, and that should increase investor demand for this offering. It’s just a mathematical calculation. At current yields, this TIPS would greatly outperform a nominal Treasury if official U.S. inflation continues at 3% or higher. Here are the numbers:
Of course, this TIPS would also be a loser if inflation doesn’t maintain at an average of 2.33% for 10 years. Over the last 10 years, inflation has averaged 1.9%, so the market is pricing in higher-than-usual inflation over the next 10 years. My conclusion: I am not at all interested in a nominal 10-year Treasury yielding 1.31%. This new TIPS is at least a bit more intriguing, even if it gets a record low real yield.
Here is the trend in the 10-year inflation breakeven rate over the last five years, showing the lofty surge higher after March 2020, when both the Federal Reserve and Congress launched aggressive economic stimulus programs:
I Bonds remain the better alternative
I always feel the need to mention that U.S. Series I Savings Bonds, which currently can be bought with a permanent fixed rate of 0.0%, are a much better investment than a 10-year TIPS with a real yield of -1.02%. The I Bond has a 102-basis-point yield advantage, earns tax-deferred interest and has much better protection against deflation.
I Bonds have a purchase limit of $10,000 per person per calendar year. So if you are interested in inflation protection, I recommend purchasing I Bonds first, up to the limit, and then consider an investment in a Treasury Inflation-Protected Security.
For investors with a longer investment horizon, EE Bonds are also very attractive in our low-rate environment. They have a fixed rate of 0.1%, but will double in value if held for 20 years, giving them a return of 3.5%. But they have to be held 20 years. If that is reasonable for you, they are a strong investment today. A 20-year nominal Treasury is yielding 1.86%, so the EE Bond has a yield advantage of 164 basis points. EE Bonds also have a separate purchase cap of $10,000 per person per calendar year.
I probably won’t be an investor in this new 10-year TIPS, but I will be watching the Treasury’s Real Yields Curve page to see if yields are surging higher. I can see the appeal for an investor who believes real and nominal yields aren’t likely to rise dramtically in the mid-term future. In fact, if you believe real yields are heading even lower, this TIPS is an attractive investment.
I will be reporting the results soon after the auction closes at 1 p.m. Thursday. Non-competitive bids have to be made before noon.
Here is a history of recent TIPS auctions of this term:
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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.