By David Enna, Tipswatch.com
Despite a flight to safety sending yields downward in the Treasury market, a new 30-year Treasury Inflation Protected Security auctioned Thursday with a higher-than-expected real yield to maturity of 0.195%, the first positive real yield for any TIPS at auction in nearly two years.
This is CUSIP 912810TE8, which received a coupon rate of 0.125% based on the auction results. So today’s investors got another thing they haven’t seen in nearly two years: A TIPS auctioning with a discounted price, because the real yield to maturity was higher than the coupon rate. The adjusted price was about $98.10 for about $100.14 of value, after accrued inflation is added in. This TIPS will have an inflation index of 1.00142 on the settlement date of February 28.
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 current U.S. inflation. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above inflation.
The last time a TIPS auction of any term got a positive real yield was for a 10-year reopening auction on March 19, 2020, amid a day of near-complete market chaos because of pandemic fears. A few days later, the Federal Reserve launched an aggressive campaign to stabilize the Treasury market, sending real yields deeply negative.
While the market had been signaling that this new TIPS would get a positive real yield, the auction result was still a surprise. At 11:10 a.m. EST, a 29-year, 6-months TIPS was trading on the secondary market with a real yield to maturity of 0.10%. After the auction’s close, that yield increased to 0.18%, a pretty impressive move higher.
Obviously, investors in this new issue wanted higher-than-market yields, and the auction delivered. The bid to cover ratio was 2.17%, a low number that also indicates weak demand.
Here is the trend in 30-year real yields over the last 11 years, dating back to before an earlier phase of Federal Reserve quantitative easing, which began in spring 2011:
This chart might tell us where real yields could be heading in coming years. Note how in 2013 30-year real yields surged higher, because the Fed raised the possibility of tapering its bond-buying program, which didn’t actually begin until early 2014. Yields began declining in 2019, as the Fed started easing off on tightening.
The difference in 2022 is that the Fed is signaling an accelerated schedule: It could begin raising short-term interest rates and gradually reducing its balance sheet within a month. In that scenario, real yields should be climbing higher, and that was probably the message the market was sending today.
Inflation breakeven rate
With a 30-year nominal Treasury trading today with a yield of 2.30%, this new TIPS gets an inflation breakeven rate of 2.11%, on a par with recent auctions of this term. Clearly, investors are not foreseeing unusually high inflation over the next three decades, despite the current surge to 7.5% in January 2022.
For investors in today’s auction, an inflation breakeven rate of 2.11% looks like a positive. Here is the trend in the 30-year inflation breakeven rate over the last 11 years:
While the 30-year inflation breakeven rate surged strongly after March 2020, with the beginning of aggressive economic stimulus by Congress and the Federal Reserve, it has now settled into a “normal range” based on historical standards.
Reaction to the auction
The TIP ETF — which holds the full range of TIPS maturities — had been trading higher all morning, indicating lower real yields. But after the auction’s close at 1 p.m. EST, prices quickly dipped, indicating a negative reaction to the auction. Since then, however, the TIP ETF has stabilized.
Investors saw a similar reaction in LTPZ, Pimco’s 15+ Year U.S. TIPS ETF. Two minutes before the auction’s close, it was trading at $80.98 a share, but four minutes later had fallen to $79.68, a drop of 1.6% in the blink of an eye.
A 30-year TIPS isn’t a highly desirable investment for small-scale investors, Non-competitive bids amounted to only $14 million of the total of $9 billion auctioned Thursday. So today’s auction showed that the market’s big money — hedge funds, pensions funds, sovereign banks — are looking for higher yields. That could be continuing trend.
The Bloomberg report on the auction theorized that a “hawkish shift by the Federal Reserve is dashing demand for inflation-indexed Treasuries.”
The auction went begging “because when the Fed hikes, their primary goal is to move long-end real rates higher,” said Gang Hu, managing partner at Winshore Capital Partners LP. “Yes, we have moved them higher by a fair amount, but to be long them is to fight the Fed.”
CUSIP 912810TE8 will be reopened at auction in August. Here’s a recent history of TIPS auctions with 29- to 30-year terms:
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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.