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.
Is there an advantage to buying at auction instead of the secondary market? Seems like buying in the secondary would give you more time to plan/wait
Buying at auction — either at TreasuryDirect or a no-fee brokerage — has some advantages: 1) the minimum purchase size is usually very low ($100 to $1,000), while purchases on the secondary market can have very high minimum purchases, and 2) a non-competitive bidder at auction (that’s all of us) gets the “high yield” no matter the result, and 3) you don’t face any fees or bid/ask spread. The TIPS secondary market isn’t heavily traded, so the bid/ask spread can be an issue.
In Thursday’s auction, 21% of investors got the high yield of 0.362%. Everyone else got something lower … the median yield was 0.3%. So getting the high yield is a good and all non-competitive bids get the high yield.
The auction negative is the uncertainty, which can work both ways, either high or low on real yield. Usually the last-day volatility isn’t dramatic, but it can be moderately high, like we saw this week. The secondary market does let you see what you are going to get before the purchase. You just have to factor in the bid/ask spread and any fees or commissions.
My reason for buying TIPS and holding them to maturity is to protect the value of the excess cash I have in my traditional IRA account, which I will need in a few years for my annual RMDs. TIPS are NOT an investment but a cash-value preservation instrument. In other words, I won’t make in money in TIPS, but I will preserve the value of my cash position. If one wants to make money, then one must invest in stocks, either dividend-yielding value stocks, such as KO or COP or PG, or in growth stocks, such as AMZN or GOOGL, and preferably both.
So I am very happy anytime a TIPS auction produces a positive real yield, regardless of its size — 0.36% vs. 0.50%, who cares? — because I KNOW that the cash that I put into TIPS will maintain its value against inflation, with a little extra bonus at maturity.
That’s a good point. My wife made the same one yesterday when I was muttering to myself out loud about the yields dropping all morning right before my very eyes. Of course, I try really hard not to admit that she’s right about anything. Occasionally I’ll do it just to see if she’s paying attention.
Oh boy, this re-opening auction didn’t work out quite the way I hoped it would. Last night, I put in 5 orders for 10K each on this re-opening auction. I figured I could always cancel them if things were headed in the wrong direction.
I got-up at 6 am PST to see what was happening (nothing good). I had until 7 am PST to unload some of the orders. As soon as I saw that the prices were rising and my chances of getting a +0.05 yield were zero, I cancelled one 10K order.
When I saw that the inflation adjusted price was over $101, I cancelled another 10K order. When the price went over $99.00, I cancelled another 10K order. I ended-up only keeping 2 of the 5 orders.
To add salt to the wound, the prices on the secondary market are currently trading below the auction price. And, I don’t even want to think about the ones that I could have purchased a couple of days ago.
Edit…+0.50 not +0.05.
I feel your pain. We have limited resources to invest, so it’s smart to try to find the best deals out there. Next month’s 10-year TIPS auction could be a good one. The problem with this one is that yields fell apart in the 48 hours before the auction.
As a neophyte at this could you possibly give your thoughts as to why the yield declined so dramatically in the two days prior to the auction?
Real yields have been very volatile for the last two weeks, with the 5-year going from -0.01% on June 10 to as high as 0.72% on June 14 (I question that one). The market is trying to figure out where the Federal Reserve is heading, and Powell seemed to calm things down this week. Today’s auction result seemed low to me given the current trend, so investor demand must have been pretty strong.
The trend has been up practically every day since June 14th. Heck, on that day you could have purchased it with an inflation adjusted price under par ($99.99). You had to figure that wasn’t going to hold. That low was about $3 down from 6/7. Today, it’s only about $1.50 down from 6/7. Just returning to the mean? Probably everyone was chasing the inflation adjustment for July. It’s just a shame they had to do it today.
Thank you both for your thoughts.
Thank you for your updates! What seems counter-intuitive about the secondary market prices of TIPs is that they follow the prices of conventional Treasuries notes and bonds up and down in the same direction. I would think that if inflation and inflation expectations are higher, TIPs prices should go up while conventional Treasuries prices should go down; and that when and if inflation expectations are lower, TIPs prices should fall while conventional Treasuries prices should move up. However, the recent realities seem to point that TIPs market prices move in the same direction of conventional Treasuries, up and down. Perhaps you may shed some light on this, David?
I canceled my orders for TIP 4 year 10 months reopening auction as the last minute today, as I believe I might be able to buy them in the secondary market cheaper in the coming days. The last purchase of the 5 Year TIPs I made was on June 14; but I have not bought more as TIPs prices have since been moving up, along with the prices of conventional Treasuries.
Real yields will go up (roughly) when nominal rates go up, and down when nominal rates go down. The variation comes when the inflation breakeven rate widens or lessens. Inflation breakevens have been declining a bit lately, and in the last few days, both nominal and real rates tracked down. It’s not unusual.
The $102.38 is based upon par value ($100). Today’s inflation factor is 1.02376. So, the par value is $100 X 1.02376 = $102.38.
If you keep the bond to maturity you’ll get that same $100 multiplied by the inflation factor for the day the bond matures.
So, you’ll be ahead of the game as long as the inflation factor on the maturity date is greater than today’s 1.02376.
I am new to TIPS (but not savings bonds). Why would anyone buy TIPS with a negative real yield?
It wasn’t necessarily a bad investment to accept a negative real yield, which means a yield that will trail official U.S. inflation. Back in December 2021 when that 5-year TIPS auctioned with a real yield of -1.508%, a nominal 5-year Treasury was then trading with a yield of 1.22%. So, if inflation runs at 8%, that TIPS would have a nominal yield of about 6.5%, much better than the 5-year Treasury at 1.22%. (Of course, a positive real yield is always preferable.)
Ya, I always thought that accepting a negative yield was bonkers. And, then last year happened. That 6.5% looks a lot better than my 3.0% CD’s. Those CD’s looked a lot better when inflation was 2.0% (or less). Now, not so much!
How did you calculate the $102.38 of principal?
Never mind, I see: $100 x 1.02376.