By David Enna,Tipswatch.com
Am I a bit disappointed? Sure, but … I’ll take it: This was the first 4- to 5-year TIPS auction to get a positive real yield since December 2019, breaking a string of nine consecutive auctions of this term with negative real yields.
The Treasury’s reopening auction Thursday of CUSIP 91282CEJ6 generated a real to maturity of 0.362%, which was at least 15 basis points lower from where this TIPS was trading just a few days ago. In fact, this TIPS opened the day on the secondary market with a real yield of 0.44%, which gradually declined through the morning to 0.40% … 0.38% … 0.37% … and finally … the auction close at 0.362%.
But consider this: In December 2021, a TIPS reopening of the same 4-year, 10-month term got a real yield of -1.508%, a whopping 187 basis points lower than today’s result. Like I said … I’ll take it.
Investors paid an unadjusted price of about $98.87 for $100 of par value, because the real yield was higher than the coupon rate of 0.125%. The adjusted price was higher, however: About $101.22 for $102.38 of principal, after accrued inflation is added in. This TIPS will have an inflation index of 1.02376 on the settlement date of June 30.
In essence, if buyers invested $10,000 in this TIPS auction, they paid about $10,122 for $10,238 of principal, and will now collect a coupon payment of 0.125% every six months and see their principal balance increase (or fall) with inflation until the TIPS is sold or matures in 4 years, 10 months.
But also note that this TIPS will get an inflation adjustment of 1.1% in July, based on non-seasonally adjusted inflation in May. The inflation index on July 31 will be 1.03487, so that $10,238 in principal will grow to $10,349 by the end of next month. Not bad, and I’m expecting at least one more high inflation month to follow, based on June inflation.
Here is the trend in the 5-year real yield over the last year, showing the strong climb higher after the Federal Reserve committed to aggressive interest-rate increases in March 2021.
The flip side of the Fed’s aggressive monetary policy is that investors now fear the threat of recession, which could push interest rates down even if inflation remains elevated. In that scenario, TIPS are an attractive investment, benefiting both from lower interest rates and high inflation. So demand for TIPS could be increasing.
Inflation breakeven rate
At the auction’s close, a 5-year nominal Treasury was trading at 3.09%, meaning this TIPS gets an inflation breakeven rate of 2.73%, well below the 3.34% recorded at the originating auction on April 29. The rate indicates that CUSIP 91282CEJ6 will out-perform a nominal 5-year Treasury if inflation exceeds 2.73% over the next 4 years, 10 months. With U.S. inflation currently running at 8.6% and likely to remain elevated for months ahead, that seems like a reasonable bet.
Here is the trend in the 5-year inflation breakeven rate over the last 12 months, showing how inflation expectations have been falling over the last several months, in reaction to Federal Reserve actions to increase interest rates and reduce its balance sheet of Treasurys:
Reaction to the auction
Years ago, I often complained that Federal Reserve Chair Ben Bernanke spoiled my highly anticipated TIPS auctions by making policy statements just before the auction. It happened a lot, and it seemed to happen again this week with our current Fed chair, Jerome Powell, testifying before Congress. His words had a calming effect on markets, with stocks rising and bond yields falling:
“We can’t fail on this. We really have to get inflation down. We’re going to want to see evidence that it really is coming down before we declare ‘mission accomplished.’ “
We’ll give this round to Powell and the calming effect should last for … days? I’m expecting more inflation scares in the near future. Inflation is a global problem, and even as powerful as the Fed is, it can’t control the global economy or really do much about soaring food and energy costs.
I was a buyer at this auction, continuing my investments in TIPS as real yields continue to rise. I would have loved to have seen a real yield of 0.50% or above, but I’m thankful I jumped aboard a positive real yield, well above yields available just six months ago.
The bid to cover ratio on this auction was 2.61, which is a solid number. The auction appeared to go off without a hitch, and both the Treasury and investors can be pleased.
Next up, on July 21, the Treasury will auction a new 10-year TIPS, offering the possibility of 1) a positive real yield, 2) a discounted adjusted price and 3) a coupon rate higher than 0.125%. It will be worth watching.
Here’s a recent history of 4- to 5-year TIPS auctions, showing the nine-auction string of negative real yields, dating back to December 2019:
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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.