Still, real yield was lower than expected as inflation expectations surged higher.
By David Enna, Tipswatch.com
The Treasury’s offering of $21 billion in a new 5-year Treasury Inflation-Protected Security resulted in a mixed bag for investors: The real yield of 1.732% hit a 15-year high and was quite positive, but that yield was a bit below market levels right up to the auction.
This is CUSIP 91282CFR7, and the auction result set its coupon rate at 1.625%, the highest coupon rate for any TIPS of this term since an originating auction on April 24, 2007. Buyers paid an adjusted price of about $99.48 for about $99.98 of accrued value and interest. This TIPS will have an inflation index of 0.99982 on the settlement date of Oct. 31.
This is the first 4- to 5-year TIPS auction to result in an adjusted price below $100 since April 26, 2010. The price means than a person who bought $10,000 in par value for this TIPS paid about $9,948 for about $9,982 in accrued value, plus a very small amount of accrued interest, about $7.
So all in all, this is a very positive result for investors. It’s baffling, though, that the Treasury had estimated the real yield of a 5-year TIPS at 1.89% at yesterday’s market close, and the most recent TIPS of this term had been trading all morning on the secondary market with a real yield of about 1.85%.
One factor is that inflation expectations seemed to surge higher, which would indicate strong demand for this TIPS, even though the bid-to-cover ratio was a mediocre 2.38. At yesterday’s market close, the Treasury estimated the five-year inflation breakeven rate at 2.46%, but this auction resulted in a breakeven rate of 2.67%. That’s a big move higher and would explain a lot of the gap between yield and expectations.
Also interesting is that non-competitive bids — made by small investors like us — totaled $256 million, nearly double the bids of $131 million for a new 5-year TIPS issued in April. But that surge higher probably had zero effect on a $21 billion offering.
Here is the trend in the 5-year real yield since the beginning of 2020, showing the remarkable surge higher after the Federal Reserve announced tightening intentions in March 2022:
Inflation breakeven rate
With a 5-year Treasury note trading at 4.40% at the auction’s 1 p.m. close, this TIPS gets an inflation breakeven rate of 2.67%. As I noted earlier, the 5-year inflation breakeven rate has been lingering around 2.45% for several days. A 22-basis-point jump is quite a move, and it indicates that investor demand for inflation protection is increasing.
Here is the trend in the 5-year inflation breakeven rate since January 2020:
Reaction to the auction
Over the last year, we’ve had a lot of upside surprises at the close of TIPS auctions, but this one was the reverse. While the real yield of 1.723% was a 15-year high and very attractive, it came in a little below expectations. (My expectations, anyway.) As you can see in this chart, the net asset value of the TIP ETF, which holds the full range of maturities, actually declined after the auction’s close at 1 p.m. That indicates higher yields.
And now, at 1:48 p.m., the real yield of the most recent TIPS traded on the secondary market has surged to 1.91%. Doesn’t make a lot of sense. I’ll look around for a logical explanation, but I don’t expect to find one. The bond market can humble you. It’s always a good reminder: never assume anything.
But I refuse to be disappointed with my purchase of a 5-year TIPS with a real yield at a 15-year high of 1.732% and a coupon rate also at a 15-year high of 1.625%. That’s a significant real yield after nearly a decade of ultra-low yields. And it means, most likely, that this TIPS will earn a return that will beat inflation, after taxes, if you are holding it in a cash or traditional tax-deferred account.
From today’s Reuters report:
“(T)he U.S. Treasury auctioned $21 billion in five-year Treasury Inflation-Protected Securities, with the high yield of 1.732% stopping short of the expected rate at the bid deadline, which suggested increased demand.
“Analysts said demand was fueled by strong participation from direct bidders. According to investment bank Jefferies, direct bidders took down 17% of the auction, which is about six percentage points higher than the average of the last four auctions. In dollar terms, Jefferies said this is the biggest takedown since December 2019.
FYI, the Treasury defines direct bidders as: “Non-Primary dealer submitters bidding for their own house accounts.” And another worthless definition, from Investopedia: “Direct bidders include primary dealers, hedge funds, pension funds, mutual funds, insurers, banks, governments and individuals.” Doesn’t that include just about everyone? More research is needed.
CUSIP 91282CFR7 will be reopened at auction on Dec. 22, 2022. Here’s a history of auctions of this term since 2019, showing the long string of negative real yields, including the record low real yield of -1.685% just one year ago.
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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.