For the first time in 2 years, a 10-year TIPS auctioned with a real yield positive to inflation and a price discounted to par value.
By David Enna, Tipswatch.com
Here I am, vacationing in the beautiful city of Prague, and the financial world is seemingly falling apart. Earlier this morning it appeared stocks were plunging again, and my soon-to-be-completed investment in a 10-year TIPS reopening looked pretty punk.
The Treasury auctioned $14 billion in CUSIP 91282CDX6 today, creating a 9-year, 8 month Treasury Inflation-Protected Security.
All morning, according to the Bloomberg Current Yields page, CUSIP 91282CDX6 was trading with a real yield to maturity of 0.09%, about 16 basis points lower than looked likely on Tuesday. It wasn’t even hanging above the coupon rate of 0.125%, which would have meant it would auction at a discount to par.
So I went to dinner with friends (an excellent roast duck with red and white sauerkraut and dumplings … and pilsner beer, of course) and figured this wasn’t going to be pretty, with demand seemingly soaring for TIPS as stocks plummeted. When I got back to my hotel room in central Prague, I found a surprise …
The auction, which closed at 1 p.m. EDT, got a real yield to maturity of 0.232%, a very high result based on where this same TIPS was trading just a hour before the auction closed. The bid-to-cover ratio was 2.24, a very low number that indicates investor demand was weak. Conclusion: We have entered a new era for Treasury auctions, with the Federal Reserve no longer bolstering demand (and lowering yields) by aggressively buying up supply.
This was the first TIPS auction of this term to get a positive real yield in more than two years. And it was also the first 9- to 10-year TIPS auction to sell at a discount to par value in two years. I was hoping to see that result (since I was a buyer at this auction) and … whew … it happened.
Investors paid an unadjusted price of about $98.98 for $100 of par value. Because of accrued inflation, the adjusted price was higher, about $102.62 for $103.67 of value, after accrued inflation is added in. This TIPS will have an inflation index of 1.03672 on the settlement date of May 31.
It’s not spectacular, but very welcome news for TIPS investors. Keep in mind that this TIPS, with a real yield of 0.232%, could out-perform the highly coveted U.S. Series I Bond, with a real yield of 0.0%. (Because of the I Bond’s better deflation protection, though, the I Bond will still probably end up with a slight edge.)
Inflation breakeven rate
I’m going to have to “ballpark” this one, since I was eating roast duck when this auction was closing. When I returned around 8 p.m., the 10-year nominal Treasury was yielding 2.84%, creating an inflation breakeven rate of 2.61% for this reopened TIPS. While this number is fairly high, it is 32 basis points lower than the number generated when this same TIPS was reopened in March.
That means this TIPS will out-perform a nominal Treasury if inflation averages more than 2.61% over the next 9 years, 8 months. Looks good to me.
Reaction to the auction
As I would expect, the auction result caused TIPS yields to rise, and that caused the price of the TIP ETF to move lower immediately after the auction close, but not dramatically. The TIP ETF has lost about a half-percentage-point of value on the day, so far. But it still has a positive 5-day trend, in reaction to overall market volatility.
It looks like the market is OK with this auction result, even though it continues a six-month trend of TIPS auctions coming in with higher-than-market real yields.
I am pleased to see this result because TIPS investors deserve yields that are positive to the rate of official U.S. inflation. Investors who have flooded into I Bonds now have a legitimate option after reaching the $10,000 per-person cap on I Bond purchases. TIPS are a little more complicated, but a high-quality, safe investment if held to maturity.
This auction closes the books on CUSIP 91282CDX6. The Treasury will auction a new 10-year TIPS on July 21. Here’s a chart of recent 9- to 10-year TIPS auctions, showing how today’s result broke a 12-auction string with below-inflation yields:
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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.