No surprises, but demand looked lukewarm

By David Enna, Tipswatch.com

The Treasury’s reopening auction of CUSIP 91282CDC2 — creating a 4-year, 10-month Treasury Inflation-Protected Security — generated a real yield to maturity of -1.508%, well off the record low for this maturity.

This TIPS carries a coupon rate of 0.125%, so buyers had to pay a lofty premium to balance off an auctioned real yield well below zero. The adjusted price was about $109.43 for about 101.19 in value, after accrued inflation is added in. This TIPS will carry an inflation index of 1.01192 on the settlement date of Dec. 31.

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.

So, while investors at today’s auction got a real yield to maturity of -1.508%, that doesn’t mean they are accepting a negative nominal return. Instead, this investment will lag official U.S. inflation by 1.508% over the next 4 years, 10 months. If inflation averages 3.0% over that time, the nominal return will be about 1.49%. To put that in perspective, a 5-year Treasury note is currently yielding 1.22%.

The record low yield for this 4- to 5-year TIPS maturity was set at the originating auction for this TIPS, on Oct. 21, 2021, with a real yield to maturity of -1.685%.

Here is the trend for the real yield of a full-term 5-year TIPS over the last three years, as estimated by the U.S. Treasury, showing how real yields have been climbing slightly higher in the wake of Federal Reserve moves to scale down economic stimulus:

Inflation breakeven rate

With a 5-year nominal Treasury trading today with a yield of 1.22%, this TIPS gets a 5-year inflation breakeven rate of 2.73%, a bit below the Oct. 21 result of 2.89%. The breakeven rate means that this TIPS will outperform a nominal Treasury if inflation averages more than 2.73% over the next 4 years, 10 months.

A breakeven rate of 2.73% certainly looks fair, given that U.S. inflation is currently running at 6.8% and looks likely to maintain a high rate well into 2022.

Here is the trend in the 5-year inflation breakeven rate over the last three years, showing that while inflation expectations surged after the pandemic mania of March 2020, they have eased off recently in reaction to the Federal Reserve’s “hawkish” announcements:

Reaction to the auction

This TIPS had closed on the secondary market Tuesday with a real yield of -1.53%, so today’s auction result of -1.508% came in slightly higher, indicating lukewarm demand. The bid-to-cover ratio was 2.42, the lowest for the 10 most recent auctions of this term. Again, indicating lukewarm demand.

The TIP ETF, which holds the full range of maturities of TIPS, had been trading a bit higher all morning, indicating lower real yields. After the auction closed at 1 p.m. … nothing happened. It looks like the Treasury market was happy enough with the auction result.

This auction closes the history of CUSIP 91282CDC2, which did manage to set the record low yield for any TIPS of this term at its originating auction. The Treasury will offer a new 5-year TIPS in April, potentially very close to the Fed’s first moves to raise short-term interest rates. Let’s hope we see some more attractive TIPS offerings in 2022.

* * *

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

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.