Treasury Inflation-Protected Securities

• Gasoline prices fell a remarkable 20.6% in April, setting off a deflationary surge across the economy.
• Core inflation fell to 1.4% year over year, breaking a 27-month streak of rates at or above 2.0%.
• Inflation-protected investments, especially TIPS, will suffer in this deflationary period.

In a stunning reflection of the current U.S. economy, the Bureau of Labor Statistics reported today that U.S. inflation fell 0.8% in April, the largest drop since December 2008, at the opening of the Great Recession. Year-over-year U.S. inflation has now plummeted to just 0.3%, down from 2.5% at the beginning of the year.

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• U.S. Series I Savings Bonds purchased from May to October will pay a composite rate of 1.06%, annualized, for six months.
• EE Bonds will continue to double in value if held for 20 years, creating a tax-deferred, compounded rate of return of 3.5%.
• Both of these savings bond investments remain superior to better known alternatives offered by the U.S. Treasury.

The U.S. Treasury just announced it is cutting the fixed rate of U.S. Series I Savings Bonds to 0.0% as of May 1, a move that was widely expected and won’t dampen the appeal of these inflation-protected savings bonds.

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• 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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