By David Enna, Tipswatch.com
The Treasury on Thursday will offer $21 billion in a new 10-year Treasury Inflation-Protected Security, CUSIP 91282CRE3. There’s a good chance this auction will generate the highest real yield to maturity for this term in nearly 18 years.
The real yield and coupon rate will be determined by the auction results. But U.S. Treasury estimates placed the likely real yield at 2.31% at Friday’s market close. The most recent TIPS of this term, issued in January, closed Friday at 2.29%.
Things will change by Thursday, but it’s clear that CUSIP 91282CRE3 will get an attractive result, historically speaking. It looks likely to place 2nd on the chart at right, under the remarkable 2.85% real yield recorded on Oct. 8, 2008, in the midst of a massive market sell-off caused by the 2008 financial crisis.
Definition: The “real yield to maturity” of a TIPS is its yield above future U.S. inflation, over the term of the TIPS. So a real yield of 2.31% means an investment in this TIPS would provide a return that exceeds official U.S. inflation by 2.31% for 10 years.
As I noted, market conditions are likely to change by the Thursday auction. The 10-year real yield dipped 4 basis points on Friday, possibly because of a flight to safety in reaction to stock market jitters. But a real yield around 2.30% seems likely. You can track the current Treasury estimate on this page after each market close.
Here is the trend in the 10-year real yield going back to the financial crisis of 2008, showing that today’s real yields are hitting multi-year highs, minus any overt financial crisis:
Pricing
Because this is a new TIPS, the coupon rate will be set at the one-eighth percentage point below the auctioned real yield. So if the real yield turns out to be 2.31%, the Treasury will set the coupon rate at 2.25%. This would be the highest coupon rate for any new 10-year TIPS since July 2007 at 2.625%.
Because the coupon rate will be lower than the real yield, the unadjusted price is going to slightly discounted. In addition, this TIPS will carry an inflation index of 1.00325 on the settlement date of July 31. In the end, the investment cost should be slightly less than par value.
Inflation breakeven rate
With the nominal 10-year Treasury note closing Friday at 4.55%, this TIPS currently has an implied inflation breakeven rate of about 2.24%, which seems entirely reasonable. That’s 26 basis points lower than the 2.50% high hit on May 4, when Brent crude prices had soared to $115. Crude prices are now down to about $88, but there is a lot of inflationary risk, possibly long-term risk.
Fixed-income investors: Do you think inflation will average more than 2.24% over the next 10 years. If “yes,” buy the TIPS. If “no,” buy the nominal Treasury.
Here is the trend in the 10-year inflation breakeven rate over the last 18 years:
In this chart, note the deep declines in inflation expectations in the two recessionary periods. It’s interesting that the breakeven rate doesn’t plunge until the recession is under way. Also, note that the breakeven rate is a lousy predictor of future inflation.
Also … I’d say the early months of a recession are a good time for traders to buy TIPS to try to catch the initial spike in yields as financial assets sell off, and then trade out when yields plummet. This isn’t my strategy, of course.
Thoughts
A chance to get the highest real yield at auction in nearly 18 years is appealing, and tempting. But I won’t be a buyer Thursday. I filled the 2036 rung of my TIPS ladder with a purchase at the January auction, getting a real yield of 1.940% — good but probably well below Thursday’s result.
There are economic forces, such as lower international purchasing and soaring U.S. debt loads, that could cause real yields to continue to climb. But a real yield in the 2.3% range over 10 years remains very attractive, especially if held to maturity. This is a new TIPS, so there is no secondary market alternative (yet) that will mature in in the second half of 2036.
If you are looking to invest, keep an eye on the Treasury’s real yield estimates, posted at the end of each market day. That’s a good indicator.
This TIPS auction closes Thursday at 1 p.m. ET. Non-competitive bids at TreasuryDirect must be placed by noon Thursday. If you are putting an order in through a brokerage, make sure to place your order Wednesday or very early Thursday, because brokers cut off auction orders before the noon deadline.
I will be posting the auction results soon after the close on Thursday. Here is a history of auction results for this term over the last 5 years:
• 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.
Treasury Inflation-Protected Securities 
Auction just ended: 2.375% Coupon, Real Yield 2.438%. Glad I bought.
Also the Bid-to-Cover was 2.31. So – demand was just OK. Not stupendous, but not awful either.
The bond market has been selling off hard. The world is starting to doubt our stellar credit rating and fed independence.
Given that the Jan TIPS are ~3% down, is this a good Tax Loss Harvesting opportunity as well to combine with the higher coupons ( old ones had 1.875 )?
Could be. I don’t ever trade out of a TIPS, so I don’t have any experience doing this. The buyer of the TIPS you are selling will be getting a real yield of about 2.33%, so in effect it is a wash. Except if you can take a tax loss that is attractive.
Unless we suddenly start voting for higher taxes and/or reduced benefits I think the Fed and Treasury will be forced by the math of the debt service to try to inflate the debt away at some point in the next 10 years. This “financial repression” was used to pay down the debt after World War II.
I think they will honor existing TIPS and I-bonds – defaulting on these would be a disaster. I think it’s a great time to buy TIPS, and probably I-bonds in November.
Problem is politicians can’t get elected on a platform planning to raise taxes or begin any serious austerity measures. So, the beat goes on…
Inflation is perhaps the worst tax for most working folks.
It’s much worse for retired folks.
I wonder why the real yields are so high currently, and how much higher they can go? What really affects the real yield? I would not expect higher inflation or higher inflation expectations, or expected inflation due to excessive government borrowing to increase the real yield because TIPS, by their nature, adjust their principal separately from the quoted real yield for whatever inflation actually occurs. David, maybe you can do an article on the history of the real yields over the past few decades and why you think they came to be what they were…
Real yields mostly track with nominal yields and nominal yields are also higher right now, with the 10-year hitting 4.60% today. If you assume a 10-year inflation rate of 2.3%, then the TIPS comes in at 2.3% real yield. Higher inflation expectations can actually cause TIPS yields to fall versus the nominal Treasury. If the expectation is for 2.5% inflation, then the TIPS yield drops to 2.1%. However, higher inflation expectations do cause nominal yields to rise, so the real yield should also rise in that scenario.
The main points, in my opinion, are: 1) Massive federal debt requirements that will worsen in coming years, and 2) foreign buyers and governments shunning U.S. Treasurys, which means less demand and results in higher yields to compensate. Also, a booming economy and stock market draws attention away from “safe” investments like TIPS, so that again decreases demand.
You say “Real yields mostly track with nominal yields”. What do you think would happen if we had inflation like the 1980s and nominal yields increased for that reason – do you think real yields would rise even more? How high do you think real yields can go on say 2, 10, and 30 year durations?
Back in September 1981, the 10-year Treasury note topped off at about 15.8%. The year before, inflation ran at 12.5%. TIPS didn’t exist at that time, but I think you could assume the real yield would have been at least 4%. It is hard to compare that era with today. I think 4% is unlikely today, but definitely not out of the question.
Well, in August 1983 the nominal yield of US treasuries was 11.85%.
Real yield was 9.4% above trailing CPI inflation of ~2.46%. Real yields remained quite strong for another 6.5 – 7 years.
As @Tipswatch mentions, if the stock market remains resilient, and confidence in both the US to repay its debt and its numbers continues to remain weak, real yields are liable to increase over time. Major changes in policy direction or world events could cause things to shift quickly.
If there is ever a time to buy TIPS, it sounds like this is it. Thanks for all the info David.
How will TIPS be affected by the government’s planned change to measuring inflation, expected to lower reported rates by 0.2%?
If the reported numbers are lower then the cost of government debt goes down which includes TIPS and we get less return…..the Fed may lower rates and so on and on. Although today’s WSJ article suggesting that 0.2% impact may not be a big deal is something I don’t agree with. Once you get on the slippery slope of manipulating economic data, especially inflation data, it creates a huge mess. I hope the issue of lack of transparency about the changes in the process of calculating inflation, as pointed out in the article, is promptly addressed.
Thank you. I was wondering whether this reduces TIPS value considerably, since 0.2% is roughly 10% haircut on current real returns.
If you meant Total Return by “TIPS Value” then lowering interest rates may improve the value of TIPS and resulting appreciation of the principal. As you can see, it gets a bit complicated. Reporting economic data for a $34 Trillion economy is hard enough, adding a manipulation variable should be a big no no. Hope there is a statue in our law to address this because trust on elected officials is, at best, waning. In short, I am not yet worrying about it and plan to buy 10 year TIPS on Thursday in my wife’s IRA.
The changes are going to be implemented by the Bureau of Economic Analysis (BEA) and could slightly lower core PCE inflation, which is a key indicator for the Fed in making rate decisions. The BEA does not calculate non-seasonally-adjusted CPI-U, which is use for TIPS and I Bonds. So this change will have no direct effect on TIPS and I Bonds, unless the BLS makes the same changes.
David, thanks!!!. He, as always, has the right final word on this when it comes to all things related to TIPS, I Bonds, Inflation…the list is long.
I too have already purchased my 2036 step for my ladder, but I’d love to lose a bet that inflation is at or below 2.35%. Maybe a recency effect or my bias against large deficits and debt, but it strikes me as optimistic.
I know it’s funny to hope your investment doesn’t pay off, but it isn’t much different than hoping your life insurance doesn’t have to pay out…
My motto has always been, “Never cheer for higher inflation.” But we get insurance just in case.