But beware: Real yields are volatile; even hour to hour
By David Enna, Tipswatch.com
Update, July 21: New 10-year TIPS gets real yield of 0.630% at auction, a nice result for investors
The Treasury on Thursday will auction $17 billion in a new 10-year TIPS, CUSIP 91282CEZ0, and this offering should be somewhat historic, for several reasons:
- That $17 billion number is the highest auction amount in history for a 10-year TIPS opening or reopening. The last auction of a new 10-year, on January 20, was for $16 billion. A year before, on Jan. 21, 2021, the size was $15 billion.
- So the amount is increasing even as the Federal Reserve is reducing its balance sheet of TIPS and other Treasurys, meaning it won’t be rolling over its current holdings. The Treasury is trusting that investor demand will pick up the slack.
- The Treasury on Friday estimated the real yield of a 10-year TIPS at 0.57%, which would be the highest real yield at auction for this term since an auction on March 20, 2020, in the midst of pandemic panic.
- Unfortunately, that Treasury estimate has fallen 15 basis points in the last week. This is the sort of volatility we are seeing in the Treasury market, every week, as the market reacts to potential Fed actions to combat inflation.
- If the auctioned real yield holds above 0.50%, the coupon rate for this TIPS will be set at 0.50%, or possibly even 0.625% if the real yield can break through to 0.625% or higher. A coupon rate of 0.50% would be highest for a new TIPS since an auction on Jan. 17, 2019.
Watching market coverage this week, I was catching the drift from “experts” that the Fed will raise short-term interest rates, probably 75 basis points, later this month and then again — possibly 50 basis points? — in September and then go quiet, waiting to see how the economy reacts. The current Federal Funds Rate is in the range of 1.50% to 1.75%, but effectively 1.75%. An increase of 75 basis points brings it to 2.50% and another 50 to 3.00%.
At this point, short-term Treasury bills are already pricing for those increases, with the 13-week Treasury yielding 2.37% and the 1 year at 3.12%. But beyond those short-term rates, the yield curve goes flat, with the 5-year Treasury note at 3.05%, the 10 year at 2.93% and the 30 year at 3.10%. That’s not good news for investors in a 10-year TIPS, because lower nominal yields will drag real yields lower, most of the time.
All this could change next week, as the bond market slushes around based on the latest “theory” of the Fed’s future actions and the effects on the U.S. economy. Inflation expectations have also been sliding lower, even after last week’s dreary June inflation report, which set annual U.S. inflation at 9.1%.
Definition: The “real yield” of a TIPS is its yield above or below official future U.S. inflation, over the term of the TIPS. So a real yield of 0.57% means an investment in this TIPS will exceed U.S. inflation by 0.57% for 10 years.
I tend to believe that if inflation continues at a pace around 4% to 5%, which seems likely for many months, real yields will have to rise as the Fed continues stepping on the brakes. So is a 10-year TIPS yielding 0.57% attractive? I’d say yes, even knowing future rates could be higher. Here is a history of the 10-year real yield from 2010 to today:
Note that we have now reached the mid-point of 10-year real yields during the Fed’s last tightening cycle, which peaked in late 2018. At that time, the 10-year real yield rose to about 1.15%. Also at that time, U.S. inflation was running at 2.2%, far below today’s 9.1%. The Fed has a long way to go before it can end the current tightening cycle.
Pricing. If the real yield of this TIPS holds above 0.50%, the coupon rate will be 0.50% and the unadjusted price should be a little less than par value. However, this brand new TIPS will have an inflation index of 1.00495 on the settlement date of July 29. Why? Because non-seasonally adjusted inflation ran at 1.1% in May, so the half-month inflation accrual for this TIPS is 0.49% on the settlement date.
The inflation accrual means that investors could be paying an adjusted price of about $100.49 for about $100.49 of value, with accrued inflation. But the price will be a bit lower because the real yield will end up being higher than the coupon rate. It could balance out, but will probably be a bit above $100.00.
Inflation breakeven rate
With a 10-year Treasury note yielding 2.93% at Friday’s close, this new TIPS would have an inflation breakeven rate of 2.36%, which seems very attractive given current conditions. I’d prefer to invest in a TIPS with a yield exceeding inflation by 0.57%, versus a straight nominal yield of 2.93%.
Here is the trend in the 10-year inflation breakeven rate from 2010 to 2022:
In this chart, note that the current inflation breakeven rate of 2.36% is 20 basis points below the rate in March 2013, when annual inflation was running at a paltry 1.5%. Markets can be weird.
The recent decline in the 10-year inflation breakeven rate indicates that real yields have been holding up better than nominal yields. It also seems to indicate fairly weak demand for TIPS right now. That could be a factor in Thursday’s auction, with the Treasury issuing a record-high $17 billion in a 10-year TIPS.
The dip in real yields last week is a negative for investors, but I’d still be very interested in this TIPS if the real yield can hold above 0.50%. If the economy seriously weakens, we have to be prepared for the Fed to attempt a rescue, as it has continuously done over the last 20+ years. This TIPS isn’t attractive enough to “bet the house,” but a sensible investment seems fine to me.
You can check the Treasury’s real yield estimates for a full-term 10-year TIPS on its Real Yield Curve page. 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 a recent history of 9- to 10-year TIPS auctions, showing the long string of negative real yields in the aftermath of the pandemic outbreak, beginning in March 2020:
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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 be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Sorry this is a late comment, just found your site, but will check in regularly..
The post says: “So the amount is increasing even as the Treasury is reducing its balance sheet of TIPS and other Treasurys, meaning it won’t be rolling over its current holdings.”
I do not understand this sentence. Does the Treasury actually have “holdings” of TIPS? The sentence would make more sense if the word “Treasury” was a mistake for “Federal Reserve”.
Yes, that was a typo. Thanks for the alert.
Looks like the second TIPS auction in a row real yields take a hit during auction day.
In the grand scheme of things, as long as it stays positive, it’s not a big deal.
Although, I’ve got to admit that it’s starting to take a psychological toll on me!
Thursday morning heads up: The European Central Bank’s decision to raise short-term interest rates by 50 basis points (a surprise move) is causing real yields to slide lower in the U.S. It looks like — at this point — the auction yield could be about 0.67%, bur yields seems to be falling. Not a huge deal, yet.
Down to 0.58% on Bloomberg.
Deja Vu all over again.
Oh, and one other thing.
This is the first rate hike by the ECB in 11 years.
That brings it’s deposit rate to ZERO.
And, we thought the FED was bad!
Wednesday pm update: The Treasury’s 10-year real yield estimate inched up to 0.66% at the close today, so the course has been positive so far.
Any latest thoughts or updates?
The 10-year real yield closed Tuesday at 0.62%, and today the yield looks pretty stable, so far, maybe dipping slightly.
If it stays around this yield level tomorrow you feel it’s a good TIPS to pursue?
As I said in the article, I will probably be a buyer.
What is the best way to monitor real yields?
After the market closes, check the Treasury’s Real Yields Curve page: https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_real_yield_curve&field_tdr_date_value_month=202207
During the live market, you can check Bloomberg’s U.S. Yields page, which lists the real yield of the most recent 10-year TIPS. That isn’t exactly accurate, but it is close, and you can follow the trend there, real time: https://www.bloomberg.com/markets/rates-bonds/government-bonds/us (That TIPS closed at 0.64% today. It’s yield should run slightly below a full-term 10-year.)
Also, while the market is live you can can catch a general trend by watching the price of the TIP ETF. If it is trading higher, yields are down. If it is lower, yields are up. It’s inexact, but a way to get a general idea.
Well Hooray! The 10 year has finally broken-even on the month. The sad fact is that any TIPS that has a positive yield at an initial issue auction is something that has become a rare and beautiful thing. Will yields continue to go up as the FED raises interest rates? One would think so. But, you never really know if the FED is going to chicken-out by the next new issue auction that’s in October for the 5 year TIPS. So, I’ve placed an order for tomorrow’s auction with some recently matured IRA CD’s. The amount will cover my expected RMD for 2032 plus a delta fudge amount in case my RMD estimates prove to be wrong.
“I tend to believe that if inflation continues at a pace around 4% to 5%, which seems likely for many months, real yields will have to rise as the Fed continues stepping on the brakes. So is a 10-year TIPS yielding 0.57% attractive? I’d say yes, even knowing future rates could be higher.”
I’m trying to understand the effect on future pricing here. For regular treasuries higher rates = lower prices. But for TIPS doesn’t higher than expected inflation mean higher yields to the TIPS holders? It seems that currently TIPS are priced based on a lower inflation projection (2.36% breakeven plus spread vs. expectations of 4 to 5%). Might that mean TIPS bought today could go up in value if inflation exceeds the current inflation projections?
Offsetting that would be the potentially higher nominal rates if the Fed continues to tighten. I agree they have a LONG way to go. As a result, I’m trying to avoid longer duration bonds at all costs.
So I would expect these TIPS to go down in value. However the benefit of locking in a positive yield might offset that?
Higher “expected” inflation has no immediate impact on a TIPS. If real yields rise, the market value of the TIPS declines. Higher inflation for a month — say, June — will increase the TIPS’ inflation accruals for the month of August. If you are holding the TIPS to maturity, you don’t have to fret about the higher real yields. At maturity, you will get par value x inflation index, and you will collect the coupon rate along the way.
The market right now is setting the 5-year inflation expectation at 2.63% and the 10 year expectation at 2.37%. Those numbers are a bit high historically, but not outrageously high. If you think inflation will be higher, TIPS are the right investment.
When you buy a TIPS and hold it to maturity, you know exactly what its real yield to maturity will be. In the case of this new 10-year TIPS, it will be around 0.59%, and your investment will earn 0.59% above official inflation for the next 10 years. What you don’t know is what its nominal yield will be. That will depend on future inflation.
If you own TIPS mutual funds or ETFs, then the net asset value will decline when real yields rise, and the inflation accruals might be able to help balance that off. So far this year, inflation hasn’t been able to balance off the price declines caused by rising real yields. But I think at this point TIPS funds are much more attractive than they were a year ago.
Thanks very much for the clear reply. I think inflation will be well in excess of the market’s estimate; inflation would have to drop off a cliff to get from the current 9%+ to an average of 2.63% over 5 years. So it sounds like I should be buying TIPS.
Monday evening update: The Treasury’s estimate of the 10-year real yield nudged higher today, closing at 0.59%. This is confirmed by the net asset value of the TIP ETF sliding slightly lower.
What’s bizarre is that the yield 3, 6 an 12 month nominal Treasuries have gone up immensely this month. At the same time, the 5, 10 and 30 nominal Treasuries have all gone down. In fact, the 1 year nominal Treasury is going for 3.06% while the 5 year nominal treasury is going for 3.09%.
I guess this shows that the “all-knowing” market really “thinks” that the FED is just going to do a few large show rates this year and then cut and run once there’s a recession. This also means that the market is “predicting” inflation at 3% for both 1 and 5 years out. I might buy that the current inflation scenario will subside after 5 years, but 1 year out?
I’ve been reading some articles from economist Nouriel Roubini (Dr. Doom). He was one of about a dozen economists that warned about the collapse of the housing market and worldwide recession as far back as 2006. Well, he’s living-up to his moniker again by predicting that the US is going to enter into a period of stagflation worse than the 70’s.
Either way, I’m converting my maturing CD’s to TIPS for as long as the positive yields hold.
“Stagflation” is definitely a possibility. The flat yield curve happened in the 2015 to 2018 cycle, too, and the economy did slow down in late 2018 and early 2019, prompting the Fed to reverse course and cut interest rates three times in the year. Then … the pandemic.
Would it be a good plan to buy the 1/15/2032 TIPS in the secondary market now as can get .593 or so real yield today for quanity of 10 and then do another 10 at this week’s auction?
This would be a total quantity of 20 TIPS (10 maturing 1/15/2032 and 10 in the new 10 year TIPS auction this week) in either a Roth or a TIRA. Any thoughts on which of these would be better as well?
As long as you are comfortable with the yield, no problem. No way to know what will happen Thursday at 1 p.m.
Curious of your thoughts on whether it is better to buy these TIPS in a Roth or a Traditional IRA as I would keep them to maturity in either case?
The generally accepted theory is to hold riskier assets (stocks) in a Roth, since this would be the last money you would withdraw. The advantage, though, is that the TIPS interest would be free of state income taxes, not true in a traditional IRA. I personally am now investing in TIPS in a traditional IRA.
what about a TIPS EFT similar SCHP? Exp ratio .04%, average maturity of 8 years and SEC yield 8.98%? Gets me liquidity if I need to sell. I am also thinking of buying in taxable account. Make sense?
I own SCHP in a tax-deferred account. It is probably the best full-maturity TIPS fund. However, since it is a fund, with no set maturity, you can lose money, especially in the short term. SCHP has a total return of -7.9% so far in 2022. (That actually makes it more attractive, probably, since some of the bond excesses have been bled out.) Just realize there is risk of losing money. If you buy a new issue TIPS and hold it to maturity, you can be 99% sure won’t lose any money.
Secondary market TIPS: I could use some help figuring out the components of a secondary market purchase from the veterans here. I’ve tried several variations and can’t match a purchase thru Schwab this past week.
* 25 $1K TIPS 0.875% 02/15/2047
* 1326 inflation-adjusted accrued principal from WSJ
* 25000 @ $95.0153 = $23753.83 Principal Amt from the Schwab receipt
* Accrued interest: $109.10 per Schwab
* Total: $28699.92 from the Schwab receipt
Not sure how we get from the $23753 principal to the $28699.92 total. Accrued interest? But $109.10 * 25 = $2727.50, which only brings it to $26481.33, still $2109.49 short of the $28.6K.
Appreciate any insights. Thanks!
Oh man, a math problem. You are buying $25,000 par value of a TIPS, but I am seeing an inflation index of 1.204 on that Wall Street Journal list. If that is right, then you are buying $30,100 in principal. The price is about $95.30 per $100, so the cost to you would be about $28,625, roughly. Add in the accrued interest and you get to $28,734, roughly.
Thanks, David, for Math on a Sunday! Looks like I had the wrong WSJ index and had thought the accrued interest was per bond. That makes sense now!
David, I’m sure you’ve addressed this previously, but can you please say something about the plusses and minuses of buying a TIPS at auction versus buying a TIPS with similar maturity from a broker, where the YTM (which I think is the real yield) is known when you place the order? Thanks!
It’s a toss up. I like to buy at auction because I write about every auction and follow the yield trends, even when I am not buying. At auction, a non-competitive bid always gets the “high” yield, which can be significant. In the last 5-year TIPS auction, the high yield was 0.362%, which was granted to only 21% of investors. The median yield was 0.300%. At an auction, you can buy any amount you want, down to $100.
TIPS aren’t heavily traded on secondary markets, so there can be a bid / ask spread and there are sometimes lofty minimum purchase requirements. Also, you might be purchasing a large amount of accrued inflation, which is at risk if we hit a prolonged deflationary period. On the plus side, if you see a highly desirable yield, you can get it … NOW. That’s an advantage over the auction process. For nearly half a year, auction yields were coming in higher than the secondary market. But that wasn’t true in that last 5-year auction, so maybe that trend is starting to reverse.
I can certainly attest to the vagaries of purchasing TIPS on the secondary market. The largest problem is that it’s the playground for the big boys (institutional investors). Usually you have to purchase at least 100K in TIPS on the secondary market to get a bid accepted. About once or twice a month, I’ve seen minimums in the 1K to 10K range. However, they tend to disappear quite quickly. Recently, I was able to place a bid for 10K that was accepted by one of the big players requiring a 100K purchase. Usually, my broker prevents those orders from even being placed. So, I’m not quite sure how that even happened!
i’ve purchased some April ’27 maturity TIPS in the secondary market within the last month at Vanguard in small amounts (a few $1000s). didn’t get the better yields available to those investing larger sums, but still got 0.50-0.55%, a little improvement on the original auction result.
I don’t know what it will look like when the market opens, but I’m looking at the Schwab site right now and it shows more than 20 TIPS maturities between 2025 and 2032 with purchase minimums of $1,000. And more than a dozen asking below par. The YTM doesn’t change when I change my purchase amount from $1K to $100K.
I agree about buying in the secondary market if you see a good yield. Usually I buy the 10 year at auction in January, but when the Fed announced they would stop buying TIPS in March, I decided to wait for the May re-opening. The week before the re-opening I saw a positive yield and bought in the secondary market for the first time. The real yields on the spread were .30/.28, but that was for 100k so I had to go down the ask list to .27 for a dealer who was selling less than that. I doubt I’m going to be grinding my teeth over a basis point or 2 in 10 years when it matures. And the yield went back down at the May re-opening so I got lucky. I’ll probably go back to the simplicity of the auction, but it really wasn’t very difficult or expensive on Fidelity to buy in the secondary market.
Speaking of the secondary market, the 28 year maturing 2/15/50 has been trading below par with an inflation factor of over 1.1 and a real yield of 1%. It seems like you’re getting all the past 2.5 years’ worth of inflation adjustments for free without any deflation risk. It’s also clobbering the 30 year I-bond’s real yield. What am I missing?
TIPS are more attractive in an IRA. I believe you can’t buy I bonds for an IRA. Also, b/c peculiar way in which TIPS are taxed, you really want them in a tax-deferred account.
Yes, this is true, but I actually own a fair number of TIPS in a taxable account and I am letting them mature. When they mature, there is very little tax consequence, since I have already paid the taxes. Now that I am retired, I’ve moved all my purchases to a traditional IRA account, where I can move money around without tax issues. Holding TIPS in a taxable account is essentially the same as holding any bond fund in a taxable account and reinvesting the dividends.
Why would you buy the new 10-year with an unknown real yield around 0.5% when you can buy the existing 3.375% coupon TIPS of 4/15/32 with a known real yield of .606% and have the added inflation protection of a larger coupon? See https://www.wsj.com/market-data/bonds/tips for yields?
I am looking at Vanguard’s site, which is quoting a yield of 0.571% on the buy side. I am not saying this is unattractive, but you will be buying an inflation accrual of 63% (not guaranteed to be returned at redemption if deflation strikes) and you will be paying a premium price of about 126.15 for $100 of value because of that gaudy coupon rate. Overall, the adjusted price is going to be $205+ for $100 of par + $63 accrued inflation. Generally, the market prices things correctly.
The expected yield for the new issue is now 0.60% on Fidelity. It seems logical the rate will (nearly) match the market, at the auction deadline.
Generally, yes, but the auction yield can vary a bit, up or down. It’s important to check how TIPS are trading through the morning of the auction.
Trying to understand how these work compared to Ibonds, Definition: The “real yield” of a TIPS is its yield above or below official future U.S. inflation, over the term of the TIPS. So a real yield of 0.57% means an investment in this TIPS will exceed U.S. inflation by 0.57% for 10 years.
Would the .57% be similar to an Ibond fixed rate and US inflation similar to the Ibond variable rate?
Yes, pretty much. I usually note that the real yield of an I Bond is 0.0% right now, because the fixed rate is 0.0%. There are differences, since the I Bond tracks “recent past” inflation and creates a set six-month interest rate. The accrued value can never go down, and the interest compounds. With a TIPS, you get the coupon rate paid out twice a year, and the principal balance adjusts daily, up or down, based on inflation two months earlier.
Also, because I Bonds have so many advantages — flexible maturity, tax deferral, deflation protection — a lot of savvy investors prefer I Bonds over TIPS until the real yield spread reaches at least 50 basis points, just where it is now. So now it becomes more of a toss-up.
I read your excellent column faithfully in hopes of becoming a savvy investor. Why do savvy investors compare the 30 year I bond real yield to that of the 10 year TIPS instead of the 30 year TIPS?
Keep in mind that the I Bond can be redeemed after 5 years with no penalty, so it is actually comparable to a 5-year bond or bank CD. A 30-year TIPS is a very long-term, very volatile investment.
Ah, of course. Thank you so much. One more small step forward in the educational process. I pray we’ll all see the current 30 year TIPS mature!