By David Enna, Tipswatch.com
The U.S. Treasury will offer $14 billion in a 10-year TIPS reopening auction on Thursday. The real yield is likely to crash through the record low for any TIPS auction of this term. And the weird thing is: Demand could be pretty high for this offering.
This is CUSIP 91282CCM1, and the auction will create a 9-year, 8-month TIPS. Here is its history:
- CUSIP 91282CCM1 was created at an originating auction on July 22, 2021, generating a real yield to maturity of -1.016%, currently the record low for any 9- to 10-year TIPS auction. It was assigned a coupon rate of 0.125%, the lowest the Treasury will go for any TIPS.
- Its first reopening auction was Sept. 23, 2021, where it got a real yield to maturity of -0.939%.
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.
When you see a negative real yield to maturity, it doesn’t mean an investor is accepting a negative nominal return. But it does mean the investment will underperform official U.S. inflation.
CUSIP 91282CCM1 trades on the secondary market, so you can track its real yield and cost 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 -1.18% and a price of $113.38 for $100 of par value.
In other words, to collect that 0.125% coupon rate plus official U.S. inflation for 9 years, 8 months, investors are willing to pay a 13%+ premium to par for this TIPS. Why? Because inflationary fears are surging. A TIPS offers protection against inflation surprises, and investors are worried about where future inflation is heading.
Here’s a simple chart that shows a key yield trend in 2021:
Since the beginning of 2021, 10-year nominal Treasury yields have increased 65 basis points, while 10-year real yields have fallen 7 basis points. That’s a swing of 71 basis points. The yield spread on that chart is equivalent to the 10-year inflation breakeven rate, and with U.S. inflation currently running at an annual rate of 6.2%, it’s conceivable the spread could continue expanding.
Here is a chart comparing the nominal yield of a 10-year Treasury note against the real yield of a 10-year TIPS, over the last two years. During the depths of market panic in March 2020, the yield spread shrank to as low at 0.50%, but has been expanding ever since.
Inflation breakeven rate
With a 10-year nominal Treasury yielding 1.56% on the secondary market, CUSIP 91282CCM1 currently has an inflation breakeven rate of 2.74%, at the very top of the Treasury’s history of the 10-year breakeven rate, which dates back to 2009. This means that a 10-year TIPS is “all-time expensive” versus a nominal Treasury. Here is the history of the breakeven rate over the last two years, showing the steady surge higher, triggered by massive economic stimulus programs launched in March 2020:
If you invest in TIPS mutual funds, you probably have noticed they have done very well in 2021; much better than the overall bond market. Schwab’s U.S. TIPS ETF (SCHP) has had a total return of 6.11% year to date, after a return of 10.86% in 2020. Compare that to Vanguard’s Total Bond ETF (BND), with a total return of -1.83% year to date, following 7.71% in 2020.
TIPS are in a Goldilocks scenario right now, benefiting from a combination of lower real yields (causing net asset values to increase) and surging inflation (adding to principal balances of all TIPS). It can’t last forever, though. In fact, the turn-around can be fast, and severe, as I noted in this article: 2013: A year of surging real and nominal yields. Here is a chart from that article, showing how the overall TIPS market under-performed as the Fed prepared to scale back its bond-buying stimulus:
Thoughts on the auction
Investors in Thursday’s auction should be aware that this TIPS will carry a very high inflation index of 1.02337, meaning that the adjusted price will be boosted by about 2.3%, but investors will receive a matching amount of additional principal. If the real yield to maturity comes in at around -1.18%, the adjusted price should be about $113.70 for about $102.34 of principal, after accrued inflation is added in. But a lot can change by Thursday.
Although I won’t be a buyer, I’m expecting reasonably strong demand for this issue. Keep in mind that the December inflation accrual will be 0.83%, based on non-seasonally adjusted inflation in October. Investors know that, and the current yield probably reflects it. But investors will recoup 0.83% of the premium price in a single month.
If you are investing, you should keep an eye on Bloomberg’s Current Yields page, which shows its real yield and price in real time. The last auction of this term, in September, got a bit of surprise boost in yield. It followed by a day a Federal Reserve announcement detailing plans for future tapering of its bond-buying program. Since then, the tapering has begun, with almost no effect on the TIPS market.
I’ll report the auction results soon after the close at 1 p.m. Thursday. Here’s a history of recent TIPS auctions of this term, showing the decline into deeply negative real yields triggered by Federal Reserve actions in March 2020:
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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.