Treasury Inflation-Protected Securities

• The new Treasury reality is negative real returns and stunningly low inflation expectations.
• The auction result of a real yield to maturity of -0.320% matched the Treasury’s overnight estimate.
• The inflation breakeven rate of 0.69% makes this TIPS – even with a negative real yield – much more desirable than a five-year nominal Treasury. But there are better alternatives.

Today’s Treasury auction of $17 billion in a new five-year Treasury Inflation-Protected Security – CUSIP 912828ZJ2 – reflected a new reality of ultra-low yields and grim inflation expectations.

Investors got a real yield to maturity of -0.320%, the lowest for any TIPS auction of this term in five years.

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• A new 5-year Treasury Inflation-Protected Security — CUSIP 912828ZJ2 — will be created at auction Thursday.
• This TIPS looks likely to get a real yield to maturity in the range of -0.20% to -0.30%, but a firm prediction is impossible.
• Reaction? It’s not an ugly investment idea, but I Bonds are clearly the better investment for your first $10,000.

This new 5-year TIPS should attract some investor interest, despite deflationary fears in the short term. A massive explosion of Federal Reserve stimulus and U.S. government deficit spending is being used to stabilize the financial system, and at least so far, it is working. The S&P 500 index is up about 22% since hitting a low of about 2,235 on March 23.

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• Real yields for TIPS are now negative across the entire maturity spectrum: 5-year, 10-year and 30-year.
• The Treasury has no reason to keep the I Bond’s fixed rate above 0.0% when the 10-year TIPS is yielding -0.50%.
• Act before May 1 to lock in the current fixed rate of 0.2%. Surprises can happen, but that rate will almost certainly fall to 0.0%.

Nothing in this world is certain, but it looks highly probable that the U.S. Treasury will lower the fixed rate on U.S. Series I Savings Bonds from 0.2% to 0.0% on May 1, the next reset date. How probable? I’d say 95%.

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• U.S. Series I Savings Bonds purchased before May 1 will pay a composite interest rate of 2.22% for six months, and then 1.26% for six months.
• I Bonds remain the world’s best inflation-protected investment, especially if you purchase them before May 1.
• Gasoline prices sent the U.S. economy into deflation in March. Deflation looks like a trend that will continue for many months.

The March inflation report, just released by the U.S. Bureau of Labor Statistics, locks in the I Bond’s new inflation-adjusted variable rate at 1.06%, down from the current 2.02%.

The new inflation-adjusted rate will go into effect May 1, when the U.S. Treasury will also reset the I Bond’s fixed rate, which is currently 0.2%. That fixed rate is highly likely to drop to 0.0% on May 1.

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• A unique feature of I Bonds is that yields are set for six-month periods and won’t change. Investors can now lock in the current yield of 2.22% for six months.
• Deflation is coming, but shouldn’t be reflected harshly in the I Bond’s next variable rate, to be reset on May 1 based on inflation from October 2019 to March 2020.
• Ideally, I Bonds are a long-term investment, part of a strategy of building inflation-protected cash. But a short-term option now opens up.

With the Federal Reserve slashing its key short-term interest rate to nearly zero on March 15, investors are going to see their return on safe short-term investments fall to zero in coming months.

Say goodbye to Treasury Money Market Funds paying interest of 1.5% or higher. We may not see those rates again for many months, possibly years.

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I Bond yield estimates