By David Enna, Tipswatch.com

The Treasury’s offering of $23 billion in a reopened 5-year Treasury Inflation-Protected Security – CUSIP 91282CNB3 – generated a real yield to maturity of 1.650%, close to what the market expected.

This TIPS was trading on the secondary market Tuesday morning with a real yield in the range of 1.63% to 1.65%. The auction generated a solid bid-to-cover ratio of 2.53 and the yield dipped slightly below the “when-issued” prediction of 1.66%. So demand was solid.

This version of CUSIP 91282CNB3 creates a 4-year, 10 month TIPS. It had its originating auction on April 17, when the real yield to maturity was a bit higher at 1.702%. The coupon rate was set at 1.625%.

Definition: The “real yield to maturity” of a TIPS is its yield above official future U.S. inflation, over the term of the TIPS. So a real yield of 1.65% means an investment in this TIPS would provide a return that exceeds U.S. inflation by 1.65% for 4 years, 10 months.

The 5-year real yield has been climbing recently as the bond market adapts to future Treasury borrowing needs. But the 5-year real yield has fallen a remarkable 90 basis points since its recent high in October 2023. Here is the trend in the 5-year real yield over the last two years:

Demand for this auction had raised some concern in recent days. From a MarketWatch report posted before the close:

Barclays rates analysts pointed to today’s $23 billion auction of 5-year Treasury Inflation-Protected Securities, or TIPS, as a potential source of concern for markets, given that the last three auctions of this type “tailed,” a sign of weaker demand.

A tail means investors demanded more yield at an auction than similar outstanding securities were being priced at in the open market.

The Barclays rates team, led by Jonathan Hill, said there also have been preliminary signs of a drop in TIPS allocations to foreign accounts.

Instead, the auction appeared to be met with good demand, with the real yield dipping slightly below the “when-issued” prediction.

Pricing

Because the real yield of 1.650% was slightly above the coupon rate of 1.625%, this TIPS auctioned at a small discount, with an unadjusted price of 99.883628. In addition, it will carry an inflation index of 1.00764 on the settlement date of April 30. With that information, we can calculate the exact cost of a $10,000 par value purchase at today’s auction:

• Par value: $10,000.
• Actual principal purchased: $10,000 x 1.00764 = $10,076.40
• Cost of investment: $10,076.40 x 0.99883628 = $10,064.67
• + accrued interest of $34

In summary, an investor placing an order for $10,000 par value paid $10,064.67 for $10,076.40 of principal on the closing date of April 30. From then on, the investor will receive inflation adjustments to principal plus an annual coupon rate of 1.625% (paid on inflation-adjusted principal) until maturity. The accrued interest will be returned at the first coupon payment on Oct. 15.

Inflation breakeven rate

With the 5-year Treasury note trading at a nominal yield of 4.00% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.35%, up slightly from recent auctions of this term. This means the TIPS will outperform a nominal Treasury if inflation averages more than 2.35% over the next 4 years, 10 months.

While 2.35% is a historically high breakeven rate, it seems reasonable in this new era of potentially higher inflation. Inflation over the last 5 years, ending in May, has averaged 4.6%. Here is the trend in the 5-year inflation breakeven rate over the last two years:

Thoughts

This auction seemed to go off without a hitch to strong investor demand, creating a slightly lower real yield than predicted. The real yield of 1.65% was well below recent auction highs of 2.242% (April 18, 2024) and 2.440% (Oct. 19, 2023), but remains attractive for the 5-year term.

It does not appear that the explosive Israel-Iran conflict has had a great effect on Treasury markets, as of yet. In other words, there’s been no flight to safety in U.S. Treasury investments. Meanwhile, the price of gold is up 4.7% over the last month. The value of the U.S. dollar is down 1.5% over the same period.

A declining dollar and potentially much higher oil prices (up 17% in one month) could trigger rising inflation in the United States, so an investment in inflation-protected investments looks like a wise choice. Investors in today’s auction aren’t going to get rich, but they could get some peace of mind.

Here are the results of 4- to 5-year TIPS auctions over the last five years, including the pathetically miserable auction of Oct. 21, 2021, with a real yield to maturity of -1.685%:

• 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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Follow Tipswatch on X for updates on daily Treasury auctions and real yield trends (when I am not traveling).

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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.