5-year real yields have increased 88 basis points in the last two months. This TIPS looks attractive, even though real yields could keep climbing.
By David Enna, Tipswatch.com
In the nine days that have followed the release of the somewhat-disturbing May inflation report, the Treasury market has been rocked by aftershocks of volatility.
In that nine-day span, the Federal Reserve opted to raise short-term interest rates by 75 basis points, no doubt triggered by the May report, with all-items inflation rising 1.0% and hitting an annual rate of 8.6%. The report showed substantial price increases in every main sector tracked by the Bureau of Labor Statistics. The average American is feeling the pain: Food prices were up 1.2% in the month, and gas prices were up 4.1%.
The May inflation report was issued on June 10, into an environment of already-rising real and nominal interest rates. It set off a wave of uncertainty in the Treasury market.
Nominal Treasurys. On June 9, the 5-year Treasury note was yielding 3.07%. It surged to 3.61% on June 14, before closing at 3.34% on Friday.
Treasury Inflation-Protected Securities. Real yields on TIPS were even more volatile, with the 5-year TIPS yielding -0.1% on June 9, rising to 0.73% on June 14 before falling to 0.54% at Friday’s close.
I’ve noted in the past that as the Federal Reserve increases short-term interest rates, the 5-year TIPS will be the auction term most likely to track higher with Fed rate increases, especially as fears of economic decline flatten the yield curve. Right now the Treasury estimates that a full-term 5-year TIPS would yield 0.54%, just 13 basis points below the 10-year TIPS.
Coming Thursday: 5-year TIPS reopening auction
The Treasury will offer $18 billion in a reopening auction of CUSIP 91282CEJ6, creating a 4-year, 10-month TIPS. This issue was originated in an auction on April 21 with a real yield to maturity of -0.34% and a coupon rate of 0.125%. It had an adjusted price of $102.76 for about $100.42 of principal. In my preview article for that auction, I noted:
If the history of the last tightening cycle repeats itself, we should see 5-year TIPS real yields rise at least another 100 basis points. But that forecast is highly uncertain ….
Two months later, the 5-year real yield has already increased 88 basis points. This TIPS, which trades on the secondary market, closed Friday with a real yield of 0.51% and an unadjusted price of $98.17, a decline of about 4% since the originating auction.
Although real yields are likely to continue climbing, I consider a real yield of 0.51% on a 4-year, 10-month TIPS to be attractive. That is a 51-basis point advantage over the U.S. Series I Savings Bond. This auction is worth a serious look.
Definition: The “real yield” of a TIPS is its yield above or below official U.S. inflation, over the term of the TIPS. So a real yield of 0.51% means an investment in this TIPS will exceed U.S. inflation by 0.51% for 4 years, 10 months.
Here’s the trend in the 5-year real yield from 2013 to 2022, showing the potential for the 5-year real yield to continue rising as the Fed continues tightening. At the end of the Fed’s last tightening cycle, the 5-year real yield hit 1.13% in mid-December 2018. I think there is potential for it to go higher this time, unless the U.S. economy drastically worsens:
Pricing. Real yields are in a volatile phase right now, so things could change before Thursday’s auction. (You can track yields in real time on Bloomberg’s Current Yields page.) But let’s say the real yield holds at 0.51% and the price is $98.17 for $100 of par value. Investors will actually be paying more at Thursday’s auction, because this TIPS will carry an inflation index of 1.02376 on the settlement date of June 30. The price should be about for $100.51 for about $102.38 of accrued principal.
That’s a rough estimate, but it means if you put in an order for $10,000 in this TIPS, you will end up paying about $10,051 for $10,238 of principal. From that point on, you will earn 0.125% plus accruals matching official U.S. inflation.
Principal balances for this TIPS will be getting a boost of 1.1% in July, based on May’s rate of non-seasonally adjusted inflation. Investors know this, and it should already be reflected in the pricing.
Inflation breakeven rate
With a 5-year nominal Treasury currently yielding 3.34%, this TIPS has an inflation breakeven rate of about 2.83%, dramatically down from the originating auction when the inflation breakeven rate was 3.34%, probably the highest breakeven ever recorded at auction for any TIPS of any term. While 2.83% is historically high, it seems very reasonable at a time when U.S. inflation is running at 8.6%.
Still, the 5-year nominal Treasury is also getting appealing, especially if you believe the Fed won’t maintain an aggressive course of tightening. I’d probably dabble in the 5-year Treasury note when yields rise above 3.5%. (The next auction of this term is coming Monday, June 27.)
On balance, though, getting a real yield of 0.5%+ makes the 5-year TIPS more appealing, since it provides insurance against unexpectedly high inflation, just like we are suffering today.
Here is the trend in the 5-year inflation breakeven rate from 2013 to 2022, showing that breakevens have slipped lower since the Fed solidly committed to fighting inflation earlier this year:
Conclusion
As long-time readers know, my investing style is to buy TIPS at auction and hold them to maturity. The 5- and 10-year TIPS are perfect for this strategy, and this one will mature in 4 years, 10 months. I’ll be a buyer at Thursday’s auction, as long as real yields hold anywhere near their current levels.
I was looking at my TIPS ladder recently and noticed I have a lot of issues maturing in 2023. Why is that? Because I was heavily buying 5-year TIPS in 2018 in the heart of the Fed’s last tightening cycle, when real yields were in a range of 0.631% to 1.129%. So, even though there are probably going to be better buying opportunities in the near future, I am going to hedge my bets by continuing to add to my holdings while real yields are improving.
This auction closes at noon Thursday for non-competitive bids, like those made at TreasuryDirect. If you are putting an order in through a brokerage, make sure to place your order Wednesday or very early Thursday, because brokers cut off auction orders before the noon deadline. I’ll report the results after the auction closes at 1 p.m. EDT Thursday.
Here is the history of all 4- to 5-year TIPS auctions over the last 9 years, showing the effects of the Fed’s last lukewarm tightening cycle (late 2014 to 2018) and then drastic easing cycle (2020 to 2021):
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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.
Treasury Inflation-Protected Securities 
Hello David,
Thank you for all your work explaining things in this great website. I have a question I have been unable to answer through web searches.
If I buy a reissued TIPS bond from Treasury Direct at auction, is the deflation protection nearly complete, as it would be for a new TIPS bond purchased at auction? Or is the reissued bond exposed to deflation risk up to its inflation factor, as it would be if the same bond had been purchased on the secondary market just before reissue?
Only the par value of the TIPS is protected against deflation. So all the inflation accrual you purchase is not guaranteed to be returned at maturity.
Once again, the yields are going in the wrong direction (+0.40). Latest price is $98.69. This pushes the inflation adjusted price over $101 ($101.03).
I’ve been following along for about 8 months now and have a quick question. I know all the advisors suggest holding TIPS in your retirement accounts for tax efficiency. My question is on the practical tax forms and application if I hold it in a normal taxable brokerage account at Vanguard. Will I receive the necessary forms I need for filing my taxes? I remember reading on your blog that I’d need to “get Excel out and go to work” but I didn’t know if that was if holding it at Treasury Direct or a more traditional brokerage (in my case Vanguard). Thanks.
I haven’t held TIPS in a taxable account at Vanguard, but I am pretty sure they will give you much better tax forms than you get from TreasuryDirect, which has 1099 forms that are clunky, long lists and take some study. Vanguard will probably make it simple, since it should be simple: a 1099-INT for the interest paid and a 1099-OID for the inflation accruals.
Now that CDs and nominal Treasuries are officially dead to me, I’m toying with the idea of starting to hold TIPS in my taxable accounts. I’ve always dreaded doing this because of the “phantom tax” of the inflation adjustment that accrued during the year. If that wasn’t bad enough there was the odd chance that you be taxed one year on a “inflation index” gain and then face a possible loss if there was net deflation in another year. The only “recent” years that had practically zero inflation were 2008, 2014 and 2015. Of course, as soon as I say that some other ugly “black swan” will swoop down and crush me!
I bought all my early TIPS in a taxable account, first at Legacy TreasuryDirect, and later at TreasuryDirect when it switched. I didn’t really see much of a negative, since the tax treatment is the same for bond funds you hold in a taxable account and reinvest dividends. One benefit of this method is that when the TIPS matures, there is very little tax consequences, unlike an I Bond, which has deferred interest. Also, there are no state income taxes owned, a benefit you lose if you hold TIPS in a traditional tax-deferred account. …. The negative: After you retire and no longer have an income stream, you have to raise money to buy TIPS, and that could generate taxes owed. So a tax-deferred account makes a lot more sense at that point.
So what’s your take if auction yield ends up being .44% after last week with yield over .7% in secondary market?
It’s disappointing, but 5-year real yields are up about 80 basis points in two months. This is still attractive as part of a program to continue buying TIPS as yields rise.
The best price that I personally saw on the secondary market last week was $97.94 ( a magical $99.99 with the inflation adjustment). The catch was that you had to buy 100K worth of TIPS to get that price (at my broker anyway. At least at the auction you get to pick the quantity you want to purchase.
The annoying thing for me is that a couple of days ago I could have purchased these TIPS at $100.38 for only a 10K minimum purchase (with inflation). Now I’m going to pay at a $100.75 based upon Bloombergs current price (with inflation). Like Mr. Enna says, in the grand scheme of things these last minute fluctuations don’t matter much.
However, it’s got me in a quandry as to how much I want to purchase at this auction. Do I just dump 10K this time around and hope for a better deal on the secondary market in the future? Or, do I pop for more based on the fact that the next month’s inflation index is going-up quite a bit due to last month’s 8.6% inflation rate?
What I do know is that I’m committed to purchasing quite a lot of TIPS this year. The question is just when. The 10 year TIPS auction for a new issue comes up next month.
If yields hold that should be a very attractive auction. Since they’d be maturing right at the time that 50% of my age cohort are dead, I’ll probably just purchase enough to cover my anticipated RMD for 2032.
Well, the yields are headed in the wrong direction today. Last night, the price was at $98.19. When I check earlier this morning it had gone up to $98.59. If that holds, these things would cost $1093.25 (on the settlement date). Does buying at an auction usually result in a better price than what’s currently on the secondary market due to the large institutional investors bids? Or, because TIPS are more attractive at this auction compared to what’s been available the last three years, should we expect the opposite?
Agree, real yields are heading down today to about 0.44% as of 11:15 a.m. TIPS yields at auction have been coming in higher than secondary market value for about half a year, but I think that trend will eventually reverse. I am going to go with that 0.44% number, for right now. Things can change.
Hi David,
I am trying to get a bit of an understanding of how future conditions affect the value of a TIPS bond if needed to sell before maturity. My intention in buying the TIPS is to protect against future inflation, but if I need to sell them before maturity, to understand what are the implications depending on if yields have increased or decreased by that time.
My understanding is as follows, but please correct any errors in logic regarding the upcoming 5 year re-issue, assuming about 0.5% real yield with coupon of .125% and an adjusted price of about $100.50.
1. If future yields fall, and thus future prices increase, this current TIPS bond would be attractive on the open market and mean selling it before maturity WOULD NOT mean taking a hit by doing so?
2. If future yields rise, and thus future prices decrease, this current TIPS bond would be less attractive on the open market and mean selling it before maturity WOULD mean taking a hit by doing so?
3. Would this same potential hit under these conditions in #2 be mitigated if holding to maturity?
thank you!
With TIPS (and all bonds), when market yields rise, the value of the TIPS falls, and when yields fall, the value of the TIPS rises. The value of the TIPS also increases over time with inflation, as long as inflation is rising. The 5-year TIPS has the lowest interest-rate risk of the standard TIPS issues, and the 30-year TIPS has very high volatility, and therefore risk.
An example: I bought this same 5-year TIPS at auction in April, when its real yield was -0.34% and its unadjusted price (ignoring inflation accruals) was about $102.33. Now that TIPS is yielding about 0.47% this morning and the price is $98.35, so it has gone down in value by about 3.8%. But its inflation index is now about 1.024, so I’ve had an inflation accrual of about 2.4%, which offsets some of the decline in value.
When you buy a TIPS, your “par value” (the underlying value ignoring inflation accruals and any premium/discount paid at purchase) is guaranteed to be returned to you at maturity. But you can still lose money if you redeem early, especially if you paid a large premium price, as investors have been doing for the last two years. Now that situation has reversed and TIPS will generally be selling at a small discount.
Tuesday evening update: This TIPS closed today on the secondary market with a real yield of 0.51% and a price of 98.18. There could be some slight pricing anomaly because of the fairly large inflation adjustment coming in the last half of this month, not reflected in the price today, but factored into the price on the settlement date of June 30. Today’s inflation index for this TIPS was 1.02206 and the June 30 number is 1.02376, an increase of 0.166%. So possibly the auction yield would be a bit higher. This isn’t usually a factor, but these are unusual times The Treasury is estimating a full-term 5-year TIPS at 0.54%, which seems in line.
I have split between notes and TIPS in the past at the 5 year maturity. Sometimes leaning more towards one than the other. It has been conclusively proven I have no ability to predict which will be superior. Seem reasonable?
When the inflation rate is 2% it sounds perfectly reasonable. At 8.6%, not so much.
Today, the 5 year note was 3.36%. That’s a 5% spread from that 8.6%.
That 5 year note is going to be underwater for at least a few more months (years?).
While the TIPS will be giving you breakeven mode. Plus a whopping 0.5%!
Usually, if I have a choice between a Treasury note and a CD, I’ll just go with a CD.
Although of late, CD’s have been lagging behind Treasuries.
However, CD’s have a few intangible features that Treasuries don’t.
With a CD at least you know how much you’re going to pay to break it.
A lot of credit unions allow you to take dividends from a CD without an EWP.
So, in a pinch you can use that interest as an emergency fund.
But lately, CD’s are such epic losers, I’ll be upping my TIPS purchases considerably.
Although I do like the logic of splitting things.
“A man’s got to know his limitations.”
What’s your opinion of buying TIPS on the secondary market vs. at auction? Do you have any best practices/cautions for secondary buyers?
I did an auction purchase for the first time last week. I liked that I had price quotations I could take or leave. Being in the Pacific Time Zone, auctions require me to put in a purchase the day before; there is no opportunity to assess last-minute market changes. That’s an unsettling feeling, even if the auction goes well.
Fairly new to the site, but your inflation-related content is so helpful – it’s really helping me get a more in-depth understanding of such a key issue to retirees like myself.
Thanks!
David F
Because I write about every TIPS auction, I focus my purchases on the auctions and I don’t know a lot about secondary market purchases. It is a bit of a guessing game, especially if you are buying through a broker hours before the auction closes. But in the big picture, the minor variations probably don’t matter.
How do you calculate that it costs $10,051 for $10,238 in principal? Please show me the math equation as I’m totally new to TIPS. Where does the yield of .51% come in? The inflation index? And the coupon rate of 0.125% is multiplied to what?
In this case I was taking $100 in value x the inflation index of 1.02376 x the discounted price of .9817.
100 x 1.02376 = 102.38 accrued principal
102.38 x .9817 = $100.50 cost
Things will change before Thursday but that is a rough estimate of the likely extra cost for extra principal.
The 0.51% real yield is based on the discounted price, which will be set by the auction. You pay a discounted price, and then you will earn a coupon rate of 0.125% paid out twice yearly and inflation accruals paid when you sell the TIPS or let it mature.
Thank you for explaining! How do you determine the discounted rate of .9817? Where do you multiply the real yield?
The price and yield I was using was Friday’s close. It will begin trading again tomorrow. You can track this 5-year TIPS here: https://www.bloomberg.com/markets/rates-bonds/government-bonds/us
you mentioned possibly dabbling in the 5 year nominal treasury auction when yield reaches 3.5% (which it briefly did in the secondary market earlier this week). long term average inflation since 1913 is around 3.2%. are you considering that long-term inflation rate, some other factors, or a rule of thumb in deciding to participate at the nominal 3.5% yield level?
I was just looking at the Fed’s last tightening cycle, when the 5-year Treasury hit a high of about 3.09% in November 2018. You have to go back to June 2008 to find a rate higher than 3.5% on the 5-year. So it looks like a promising starting point.
That history of the last nine years shows what a relatively good “deal” this auction might be.
Only one auction sold for an inflation adjusted price below $100.00.
Only one-third of the auctions sold for an inflation adjusted price below $101.00.
The remaining two-thirds sold over that (all the way up to $109.61, which is obscene).
This is just another example of how the FED’s ZIRP and QE have decimated the bond market.
Hopefully, this reprieve from ZIRP and QE will contiinue for the next few years.
However, with the government debt to GDP ratio at 124%, that’s probably a pipe dream.
I also own those 2018 5 year notes. They are trading above their indexed value. At what point would you sell these to capture the gain? Or just hold to maturity? I own them in an IRA. Maybe you could write an article about this. Thanks for all of the great information that you provide.
For me, this is an easy decision: I always hold TIPS to maturity. I’ve never sold a TIPS early.