By David Enna, Tipswatch.com
That worked out well. A bit of jawboning earlier this week by Federal Reserve governor Christopher Waller sent both real and nominal yields climbing in the days ahead of the Treasury’s $18 billion offering of a new 10-year TIPS, CUSIP 91282CJY8.
Today’s auction result was good for investors: A real yield to maturity of 1.810% (the third highest auctioned yield since July 2009) and a coupon rate of 1.75% (the highest at auction for this term since April 2009).
At $18 billion, this was the highest amount ever offered for a new 10-year Treasury Inflation-Protected Security, and yet demand looked strong. The auction got a bid-to-cover ratio of 2.62, the highest for this term in three years. And the real yield to maturity of 1.810% was actually slightly below the “when-issued” prediction of 1.825%.
Waller, the Fed governor, said Tuesday he saw “no reason to move as quickly or cut (interest rates) as rapidly as in the past.” That shook up the bond market, pushing real yields up about 10 basis points in two days. Yield expectations for this auction rose from about 1.69% on Friday to 1.80% leading into Thursday’s result.
Definition: A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So, the “real yield to maturity” of a TIPS indicates how much an investor will earn above inflation each year until maturity.
Here is the trend in the 10-year real yield over the last two years, showing that a recent downward trend has reversed this week:
Pricing
Based on the auctioned real yield of 1.810%, the Treasury set the coupon rate for this TIPS at 1.75% and investors therefore got it at a discounted price. In addition, the new TIPS will have an inflation index of 0.99896 on the settlement date of Jan. 31.
Here is how the pricing would work out for a $10,000 purchase:
- Par value: $10,000
- Inflation index at settlement date: 0.99896
- Principal purchased at settlement date: $9,989.60
- Unadjusted price: 99.454975
- Cost of investment: $9,989.60 x 0.99454975 = $9,935.15
- Plus accrued interest of about $7.68.
In summary, an investor purchasing $10,000 par of this TIPS will pay $9,935.15 for $9,989.60 of principal and will then receive inflation accruals and an annual coupon rate of 1.75% on adjusted principal for the next 10 years.
Inflation breakeven rate
At the auction’s close, a 10-year nominal Treasury note was trading with a yield of 4.15%, creating an inflation breakeven rate of 2.34% for this new TIPS. It means the TIPS will outperform the nominal Treasury if inflation averages more than 2.34% over the next 10 years. This rate, while historically a bit higher, is in line with other recent auctions of this term.
Over the last 10 years, U.S. inflation has averaged 2.8%. Here is the trend in the 10-year inflation breakeven rate over the last two years, showing how inflation expectations have drifted lower in reaction to Federal Reserve tightening:
Reaction to the auction
I set my focus set on this auction for several months because this is the first TIPS maturing in 2034 and fills a spot on my investment ladder. I am pleased with the result. Just a few days ago, I didn’t expect to get a coupon rate above 1.625%.
The TIP ETF, which holds the full range of maturities, nudged slightly higher after the auction’s close, which indicates the bond market was pleased. (Remember that the “when-issued” yield prediction was slightly higher, so demand was strong.) The bid-to-cover ratio of 2.62 reinforces that impression.
So we get a good result from the first TIPS auction of the year. Coming next month is the Feb. 22 auction of a new 30-year TIPS. Although I won’t be a buyer, the recent steepening of the yield curve could make this attractive for investors who can withstand both the term and volatility.
Then, on March 21, today’s 10-year TIPS will be reopened at auction.
Here is a history of recent 9- to 10-year TIPS auctions. Note that just a bit more than two years ago, a November 2021 reopening auction set the record for the lowest real yield in history for this term, -1.145%. Today’s auction was 295 basis-points higher. Cheers!
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• Upcoming schedule of TIPS auctions
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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.Please stay on topic and avoid political tirades.
David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing
Treasury Inflation-Protected Securities 
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Anyone who feels like they missed out on this auction: Yields on the secondary market are moving higher. I just bought through Schwab brokerage at YTM 1.866% ($98.951 per $100) available in amounts as low as $1,000.
For non-IRA accounts, it is difficult to consider TIPS, especially the longer duration ones.
Given today’s relatively lower treasury bills / notes / bond rates even though they are moving upwards past 2-3 days or so, i would consider non-brokered CD’s – this website author, just like David does excellent service for TIPS, has done excellent job for Certificate of deposits and writes blog articles that are good to know. Also daily updates to Online Cd rates, local rates etc. This link is for ONLINE RATES https://www.bestcashcow.com/cd/online-rates – many credit unions also offer good rates but mostly restrict access to select few. Author has written articles on why he feels brokered CD’s are disadvantageous compared to holding them directly with the bank, even if inconvenient opening and maintaining in multiple banks.
TIPS of any duration make sense for IRA, especially now the fixed rate is still high compared to past years………
However, in non-IRA, why would anyone wish to pay taxes on the accrued principal every year given that accrued principal is only paid upon sale or maturity of the security. I can understand the requirement to pay taxes on the coupon interest paid bi-annually in same tax year. But on accrued principal, paying annual taxes doesnt make sense as one would need to pony up some extra money if FIXED RATE is not high enough to cover tax payments on accrued principal.
Ofcourse, since taxes are all paid up, this TIPS in non-IRA account will make for an excellent inheritance…..thats the only advantage I see!
I think this depends on your age. Back in 2000, when I was in my late 40s, I started buying TIPS in taxable account at TreasuryDirect. I have never sold any of those TIPS and still have a collection there, maturing in every year from 2024 through 2029, and one more in 2041. While I was still working, there wasn’t much of an issue of 1) raising money to buy TIPS or 2) paying the taxes due. It is pretty much exactly like holding a bond fund in a taxable account and reinvesting interest. You pay the taxes and the interest is added to your basis. When the TIPS matures, you owe almost no tax, and that is very nice for these years 2024 through 2029. I enjoy getting the tax-free spending money.
But after retirement, buying TIPS in a taxable account make less sense because how do you raise money to buy TIPS without incurring taxes, and then you will owe taxes on the inflation accruals, but you don’t have as much incoming income. At that point, TIPS in a tax-deferred account are much more preferable. Before retirement, honestly, tax-deferred is also the way to go, but the advantage isn’t as great and if you live in a high-tax state, the interest is not taxable. This isn’t true in a traditional IRA.
I agree. It all depends on time and one’s situation. I am thinking aloud at this time as it is time to make a decision on taxable accounts and the pendulum is swinging this way and that as new data pours in!
Now that I put some more incremental thought into this after reading your response, for CD options for non-retirement account, I feel the brokered CD’s give regular income paid into the account whereas CD’s bought from banks, one must make sure it is not compounded which then becomes like this accrued principal on TIPS and bond funds you speak of……where you dont get interest in hand but pay taxes out of hand……..again, in some situations and for some durations, it all makes sense, one must consider for oneself what makes sense and when where how and why.
This author articulates much better than I can these additional considerations for taxable account options – https://www.bestcashcow.com/3-simple-reasons-to-never-ever-buy-a-brokered-cd.html https://www.bestcashcow.com/long-term-treasurys-make-sense-as-a-trading-vehicle-but-.html
All situation dependent – I’ve been buying a few hundred of TIPS in the past few auctions for my child in a minor-linked Treasury Direct account. She doesn’t need to file if she has under $XXXX amount of unearned income (I forget the exact amount) so a 10 year TIPS is (potentially) a better investment for her than I-Bonds, which if she holds until she is an adult she will have to pay tax on the interest. So I have her investments split between I-Bonds and TIPS. This way, I can also reinvest the the meager coupon in different ways to make myself think I’m maximizing her return. And she’s set up to pay for her first fender-bender when this 10 year TIPS matures.
I invest in Treasuries for myself through Treasury Direct because I can do it in small increments and place or accumulate money for certain known costs across time. I have the Treasury withhold 15% for taxes, which is more than my marginal rate to cover the OID on the recently increasing TIPS portion. I might stop doing that because it’s not really worth it – I don’t pay that much in taxes and don’t make enough in interest or OID to cause me problems.
In the end, I just like to make my life complex…
I live in a “high tax” state, so I prefer my TIPS and I-bonds in a non tax-deferred account. Although I’m retired, fortunately I have enough other income to cover the ongoing taxes. I-bonds are more problematic, as much of the value when redeemed will be taxable, and could result in bumping us up to a higher tax bracket. But, who knows what the tax code will be decades down the road…
Interest from I Bonds is not taxable at the state level, so that isn’t an issue. But yes, you could face higher marginal federal rates and potential for Medicare surcharges. My gut feeling on taxes is that the rates won’t be going lower than they are today. Probably higher.
My first buy of TIPS at auction (via Vanguard). Like you, I was pleased with the outcome. Your information helped a lot in making sense of a somewhat arcane process. Thanks so much for all your excellent assistance to your readers.
Wow, negative inflation adjustment!
More coming in February for all TIPS, down 0.1%. Not unusual because of end-of-year non-seasonal inflation.
Do I understand correctly that the interest payment on a tips increases and compounds over time, assuming no deflation? If we were to see a constant 3% CPI, would the interest payments increase by 3%/year? So the payments toward the maturity date are much higher than where they start out, again assuming no deflation?
Thanks for your help. When I first learned of tips I thought I’d never buy any due to the complexity. Slowly, they become a bit less mysterious.
The coupon rate stays the same but as the underlying principal increases with inflation, the coupon payment increases.
David, your analyses and insight helped me to purchase today my second TIPS ever. Grateful. Thank you.
David, I thought I was pretty well educated on TIPS and all their peculiarities, and I already own a significant sum and even purchased more today for my 2034 ladder rung, but you used a term in today’s post which was new to me. Please provide guidance or point me to where I can find info about your comment on the “when-issued” prediction of 1.825% yield.
Thanks for all our work and education on these investments.
This “when-issued” number is used by the big bond traders to predict (probably fairly accurately) what the auction result will be for a new issue, since there is no matching security currently trading. It does actually involve real trading before the bond is issued, so people are putting money on the line. I can’t see the number before the auction’s close. I wish I could, but after the auction result it gets posted. More information from the New York Fed: https://libertystreeteconomics.newyorkfed.org/2020/11/treasury-market-when-issued-trading-activity/
Thanks for the quick reply and continued education.
My earlier comment should have been: Thanks for all YOUR work and education on these investments.
My future self is now funded for 2034! Always a nice feeling to get a better ytm and coupon rate than expected.
An “impulse buy” for me, when I saw how rates were creeping up. Pleased with the outcome. Thanks for all your informative posts, David.
I was pleased with the final numbers, especially given recent results (and swings just prior to closing), my expectations were lower.
David, thanks again for all you do to keep me (us) educated/updated on these Treasury offerings.