By David Enna, Tipswatch.com
I am writing this after an evening out in Biella, Italy, and while struggling with rather weak Internet. So this is going to be brief.
The U.S. Treasury’s auction of $19 billion of a new 10-year Treasury Inflation-Protected Security, CUSIP 91282CLE9, generated a real yield to maturity of 1.883%. The coupon rate was set at 1.875%, the highest for this term since July 2009. That was 88 auctions ago for this term of TIPS.
While the coupon rate set a milestone, the real yield to maturity was below the last two auctions of this term, which hit a multi-year high of 2.184% in a reopening auction on May 23, 2024. That was CUSIP 91282CJY8, which was trading Thursday morning with a real yield to maturity of about 1.91%, a bit higher than this auction result.
The “when issued” prediction for this new TIPS, set just before the auction’s close, was for a real yield of 1.865%. The auction came in a bit higher at 1.883%, which indicates slightly weak demand. The bid-to-cover ratio was 2.38, slightly higher than recent auctions of this term.
So … all things considered … this looks like a routine auction. No surprises.
Pricing
This TIPS will have an inflation index of 1.00086 on the settlement date of July 31. It auctioned at an unadjusted price of 99.926982. Those two factors combine to create an adjusted price of 100.012919.
So an investor purchasing $10,000 par value of this TIPS will be receiving $10,008.60 in principal on the settlement date, at a cost of about $10,001.29, plus about $8.16 of accrued interest, which will be returned at the first coupon payment in January.
This TIPS auctioned at a total cost very close to par value, which is the amount guaranteed to be returned at maturity, even after a severe period of deflation. (That is comforting, but a very, very minor issue.)
Inflation breakeven rate
With a 10-year Treasury yielding 4.18% at the auction’s close, CUSIP 91282CLE9 gets an inflation breakeven rate of 2.27%, lower than the last four auctions of this term. This means the new TIPS will out-perform a similar Treasury note if inflation averages more than 2.27% over the next 10 years.
Here is a history of TIPS auctions of this term over the last three years:
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• Now is an ideal time to build a TIPS ladder
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• TIPS investor: Don’t over-think the threat of deflation
• Upcoming schedule of TIPS auctions
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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.
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Also note that the Fed target is based on PCE, not CPI and CPI tends to be a bit higher, making the TIPS look even better.
OTOH, 20 year nominal treasuries have a bit higher yield than 30 year. And you can probably can get a “long enough” treasury or STRIP at around 4.4-4.5%, increasing the break-even inflation rate to more like 2.4%. (I see some bonds and STRIPS maturing in late 2040s to early 2050s with ask yields around 4.4-4.5%.)
And of course rates are back up today. Go figure. All good!
When I presented on the deficit and high inflation in my Econ 101 class, as a newly minted libertarian and college freshman in 1982, I’ll admit it was a bit overwrought with emotional appeal. National Debt to GDP ratio was climbing quickly but still well below 40% (vs. over 120% now) and inflation was 7-10% annualized. The professor was Robert Gordon at Northwestern University, described in Wikipedia as, “Gordon is one of the world’s leading experts on inflation, unemployment, and long-term economic growth.” He was rather dismissive but, in retrospect, fortunately right so far (though I doubt he would have predicted trillion dollar annual deficits with negligible inflation).
I was headed to Wall Street but graduating in Fall of 1987 was terrible timing …..I was on the trading floor of the Chicago Mercantile Exchange then trying to get a company out of a bad foreign currency bet while finishing school at night….It was the exact same type of bet made by 25 year olds that Long-term Capital Management made 10 years later and was described in the book “When Genius Failed.” Same math – different scale. Lesson learned with “Other people’s money”, I invested primarily in stock and bond index funds, plus some real estate for the next 35 years and spent most of my career working at a nonprofit. I didn’t read another investment book or newsletter until this newsletter a few years ago. I only made one big bet from 1987 to now: don’t make long-term loans at negative real interest rates to Uncle Sam or anyone else.
Now managing cash flow for withdrawals, with no annual raises or rental income increases, plus Social Security 7-10 years away….This newsletter, and the associated comments, have been a highlight the past few years as I’ve learned more about I-Bonds, TIPS and Treasuries than I did in my graduate course on public debt finance (where an I-Bond proposal would have been laughed at even more than my presentation on egregious deficits debt). I greatly appreciate the clarity, intelligence, and no conflicts of interest. And pragmatism…My ladders are built and easy to maintain. I now manage Treasury Direct accounts for several nonprofits and advised several more to open them vs. paying exorbitant fees to a manager to buy T-bills and Notes….they appreciate saving thousands a year.
So, a long but I hope a bit interesting way of saying “thank you” and I look forward to reading for many years as I maintain my ladders and help others. And, in 1982 I’d never have guessed that in 2024 I’d pause and think twice about a bet on a break-even annualized inflation rate of 2.27% vs. a 10 year Treasury ;).
Awesome post. Thank you for the wisdom and kind words.
After taxes (which I assume are paid on the inflation adjustment component as well as the coupon) how does the $in less $out match up. In perhaps simpler terms will the overall cash flow to maturity be positive or negative?
Most people buy TIPS in a tax-deferred account. Cash flow is highly likely to be positive with the coupon at 1.875%.
Looks like an amazing location, David. I picked up some at auction. With a market open today for the 10yr TIPS at 1.898%, a high of 1.929% in the am, and $1.910% at abt 12pm, what factors brought down the real yield lower to 1.883%? The coupon was as you predicted, so glad to have gone in this time. Thanks. Enjoy!
Auctions are unpredictable because in this case you had $19 billion in a new TIPS. Big-money buyers may need the auction to fill their needs, more than easily available on the secondary market.
Don’t waste the vermouth! Enjoy!
Great photo in the email newsletter. Thanks for the TIPS on a pretty town to visit in the Alps. 🙂
Coupon rate is 1-7/8% = 1.875. Vagaries of road internet.
Totally true. This post had to be rushed, unfortunately. Thanks for the heads up. It is fixed.