Treasury Inflation-Protected Securities

The Treasury will auction a new 30-year Treasury Inflation-Protected Security – CUSIP 912810RR1 – next Thursday. The coupon rate and real yield to maturity (after inflation) will be determined at the auction.

Here’s what we can say today, a week away from the auction:

• The measure I trust the most for a new-issue TIPS is the Treasury’s Real Yields Curve Rates page, which updates every weekday with an estimate of the yield on a full-term TIPS. For a 30-year TIPS, this measure was set Wednesday at 1.06%. This is down 19 basis points from where it started the year.
• Bloomberg’s Current Yields page gives a real-time look at the trading for the most recent 30-year TIPS, which matures in 29 years. It is currently trading with a yield of 1.03%.
• And the Wall Street Journal’s Closing Prices page shows that 29-year TIPS, which matures in February 2045, closed Wednesday with a yield of 1.047%.

So at this point, a week from the auction, it looks like this new TIPS will auction with a yield of 1.06% and a coupon rate of 1.0%. Given those numbers, I’d have to say this one doesn’t look like a great deal for the buy-and-hold investor – especially if the 30-year lifespan falls outside your own likely lifespan.

For a buy-and-trader, 30-year TIPS are extremely volatile investments. The 30-year TIPS auctioned last February – CUSIP 912810RL4 – has lost about 8% of its market value in the last year. At the same time, its inflation index has climbed only 0.6%. Buying a new TIPS with a coupon rate of 1.0% as a buy-and-trade investment is a bet on recession, in my opinion.

On the positive side: The inflation breakeven rate. A nominal 30-year Treasury is trading right now with a yield of about 2.53%, setting up a very low inflation breakeven rate of 1.47% for this new 30-year TIPS. And that’s why this TIPS will have appeal for big-money investors. It inflation averages more than 1.47% over the next 30 years, the TIPS will outperform the nominal Treasury.

This chart shows just how dramatically low that breakeven rate is:

I’d argue that the very low breakeven rate builds in a ‘margin of safety’ for this TIPS, because if overall interest rates rise, its market yield could climb much more slowly than a traditional Treasury’s. For example, if the 30-year Treasury yield climbed to 4.0% – or about 147 basis points, the yield on a 30-year TIPS might rise to only 1.80%, or 74 basis points. That would set the inflation breakeven rate at a more normal 2.2%.

At any rate, this one doesn’t fit my purchasing profile, so I won’t be a buyer. A yield of 1.06% falls into the lower range of recent 29- to 30-year TIPS auctions, as you can see from this chart, showing all auctions of this term in history:

The Treasury’s reporting tools were down at 1 p.m., but reader Ron came through with a link to the auction report. And now the tools are back up! Anyway …

A new 10-year Treasury Inflation-Protected Security – CUSIP 912828N71 – auctioned today with a real yield (after inflation) to maturity of 0.725%, the highest yield for any 9- to 10-year TIPS auction since May 2011.

The coupon rate was set at 0.625%, meaning investors are getting this TIPS at a discount, an adjusted price of about $98.95 for $100 of par value. Part of that adjustment was due to the fact that this TIPS will have an inflation index of 0.99905 on the Jan. 29 closing date. In other words, a buyer of $10,000 will have $9,905 on the settlement date.

Inflation breakeven rate. With a nominal 10-year Treasury trading right now at 2.03%, this TIPS gets an inflation breakeven rate of an ultra-low 1.30%. That means if inflation averages more than 1.3% over the next 10 years, this TIPS will outperform a nominal Treasury. That’s astounding, and indicates 1) the market is pricing in extremely low inflation over the long term, or 2) the market is adjusting to the idea of a near-term recession. Here are breakeven rates over the last six years:

Reaction to the auction. Today’s yield was much higher than I expected, by at least 8 basis points, based on market data from earlier Thursday. That thinking is backed up by the market’s reaction immediately after the auction: The TIP ETF fell sharply, indicating higher yields.

From the Reuters report:

U.S. Treasuries prices extended their earlier drop on Thursday after weak investor demand at a $15 billion auction of 10-year Treasury Inflation Protected Securities resulted in their highest yield since May 2011.

After watching TIPS auctions for 5 years, I can say ‘always be ready for surprises.’ Today I got a pleasant one.

The Treasury closed its auction of a new 10-year Treasury Inflation-Protected Security at 1 p.m. today, but the reporting tools on the TreasuryDirect.gov site are completely down. There is no way to locate any auction announcements, past or present.

So far, no other news media have reported the results. (I am usually the first.) I’m looking and I’ll post what I find, when I find it.

The Treasury will be creating CUSIP 912828N71 – a new 10-year Treasury Inflation-Protected Security – at an auction that closes at noon for non-competitive bids and 1 p.m. for competitive bids.

Here’s where we stand at 9:45 a.m. Thursday:

• I am going to use yesterday’s Real Yields Curve estimate from the US Treasury as my baseline for this issue. It closed Wednesday at a real yield of 0.69% – exactly where it started the year. This is an estimate of the yield of a full-term 10-year TIPS.
• However, Bloomberg’s Current Yields page – which gives real-time quotes – shows a 9-year, 6-month TIPS currently yielding 0.62%, which is pretty wide spread from the Treasury number.
• The Wall Street Journal’s Closing Prices page shows that TIPS – which matures in July 2025 – closed yesterday with a yield of 0.643%.
• The TIP ETF just opened higher at $110.32 and has since risen to $110.42 This indicates that TIPS yields are on the decline. Keep an eye on this number if you are investing in this TIPS.
• The stock market has opened slightly lower – not a major move.

Tough call on where this yield will land. I’d guess at this point it will be below yesterday’s estimate of 0.69% and above the real-time yield of 0.62% on a shorter-term TIPS. Splitting the difference gives you a yield around 0.65% or 0.66%, which would be about where a 9-year, 8-month TIPS reopened at auction last November.

Hard to figure the demand on this issue. If the stock market decline is signalling a recession, that might mean lower interest rates and possible deflation in the future. Would a traditional Treasury be more attractive? But it is yielding only about 2.01% right now – 23 basis points lower than the beginning of the year. That is creating an ultra-low inflation breakeven rate of around 1.36% for this TIPS.

The market is betting on very low inflation over the next 10 years. I’d say this TIPS appears to be a screaming buy versus a traditional Treasury. However, if you believe extended deflation is looming, the traditional Treasury is the way to go.

At this point I think today’s auction is worth a small investment.

I’ll be posting results after the close at 1 p.m.