Investors benefited from turmoil in the financial markets.
By David Enna, Tipswatch.com
In the midst of a highly volatile bond market, the Treasury’s offering of a reopened 10-year TIPS — CUSIP 91282CEZ0 — generated a real to maturity of 1.248%, the highest for any auction of this term since July 2010.
This was a stunning result, but also predicable, after the Federal Reserve yesterday made clear its intention to battle soaring U.S. inflation to the bitter end, suggesting increases in interest rates would continue well into 2023.
The result was also historic, because the real yield was the highest for any TIPS auction of the 9- to 10-year term since July 8, 2010, when a new issue 10-year TIPS got a real yield of 1.295%. Since then, there have been 73 TIPS auctions of this term, all of them with real yields below 1.2%. Until today. And it is amazing to consider that less than a year ago, on Nov. 18, 2021, a 10-year TIPS reopening got an all-time low real yield of -1.145%, 293 basis points below today’s result.
At times this morning, this TIPS was trading on the secondary market with a real yield of 1.28%, so the auction ended up a bit lower, indicating strong demand. The bid-to-cover ratio was 2.54, also indicating decent demand.
Definition: The “real yield” of a TIPS is its yield above official future U.S. inflation, over the term of the TIPS. So a real yield of 1.248% means an investment in this TIPS will exceed U.S. inflation by 1.248% for the next 9 years, 10 months.
Here is the year-to-date trend in 10-year real yields, showing the steady surge higher since the Federal Reserve unveiled its inflation-fighting plans in March:
Pricing for the auction
CUSIP 91282CEZ0 carries a coupon rate of 0.625%, set at the originating auction two months ago, on July 21, when it auctioned with a real yield of 0.630% (attractive at the time, remember?). Because today’s real yield was nearly double the coupon rate, buyers got it at a substantial discount — an unadjusted price of about $94.27 for $100 of par value.
This TIPS will have an inflation index of 1.01972 on the settlement date of Sept. 30, so investors bought an additional 1.97% of principal, plus about 13 cents of accrued interest per $100. The adjusted price was about $96.13 for about $101.97 of principal, once accrued inflation is added in.
An investor putting in an order for $10,000 of this TIPS paid about $9,613 for about $10,197 of principal, as of September 30.
Inflation breakeven rate
With a 10-year nominal Treasury trading with a real yield of 3.68% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.43%, meaning it will out-perform the nominal Treasury if inflation averages more than 2.43% over the next 10 years. That result is in line with most auctions over the last two years.
Although 2.43% for a 10-year inflation breakeven rate is historically high, it seems very reasonable at a time when U.S. inflation is running at 8.3%. Inflation over the last 10 years, ending in August, has averaged 2.5%.
Here is the year-to-date trend in the 10-year inflation breakeven rate, a rather wild track higher into the spring and then much lower through the summer. The financial markets are buying the premise that the Federal Reserve can get U.S. inflation under control.
Reaction to the auction
Investors in today’s auction (I was one of them) benefited from the Fed’s hawkish statements Wednesday and the market disruptions they caused. For investors, getting the highest real yield for this term in more than 12 years was very, very welcome.
As I noted, the auction’s real yield result was actually a bit lower than where this TIPS was trading before the auction close, which indicated decent demand. After the auction’s close at 1 p.m., the TIP ETF — which holds the full range of maturities — got a slight boost higher. It had been trading substantially lower all morning.
The TIPS market has been largely ignored by investors for several years. That includes small-scale investors who have been piling into inflation-tracking I Bonds with a gaudy current annualized rate of 9.62%. But I Bonds carry a real yield of 0.0%, based on the current fixed rate. This 9-year, 10-month TIPS has a real yield of 1.248%. That’s a 125 basis-point advantage.
I Bonds have many advantages over a TIPS: flexible maturity, better deflation protection, tax-deferred interest, ease of ownership. But at this point, as long as real yields remain substantially positive, TIPS are a highly attractive investment to add to your inflation-fighting arsenal.
Here is a history of 9- to 10-year TIPS auctions over the last three years:
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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.