Treasury Inflation-Protected Securities

The Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 0.5%.

Both food prices (down 0.1%) and gas prices (down 2.4) contributed to the flat inflation number. Core inflation – which strips out food and energy – was up 0.2% in November and now has increased 2.0% over the last 12 months. That’s right on the Federal Reserve’s target, although the Fed tracks a slightly different index.

Today’s numbers shouldn’t sidetrack the Federal Reserve’s expected move to slightly raise short-term interest rates after its meetings conclude Wednesday afternoon.

Holders of Treasury Inflation-Protected Securities and I Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust the principal balance on TIPS and set future inflation-adjusted interest rates for I Bonds. In November, the CPI-U inflation index fell to 237.336, down 0.21% from October’s number.

For the current I Bond adjustment period (September 2015 to March 2016) inflation is  running at -0.25%.

I have updated my Tracking Inflation and I Bonds page with these new numbers.

I noticed the TIP ETF – which holds a broad range of Treasury Inflation-Protected Securities – dropped to $109.52 today, down 0.73% for for the day. Here are the Treasury’s estimates of today’s real yields (after inflation) for full-term TIPS versus the beginning of the month.

• 5-year. The real yield stands at 0.49%, up 19 basis points from Dec. 1
• 10-year. The real yield stands at 0.78%, up 20 basis points from Dec. 1.
• 30-year. The real yield stands at 1.32%, up 18 basis points from Dec. 1.

Tomorrow at 8:30 a.m., we’ll get the November inflation report — the consensus estimate is for a zero increase – 0.0%, leaving inflation at about 0.2% over the last 12 months. If the actual number varies highly from 0.0%, it could upset the TIPS market. A deflationary number could stall any move by the Federal Reserve. However, we can be sure the Fed already knows what the number will be, and the Fed has been signaling toward a very small increase in short-term interest rates.

Wednesday afternoon – about 2:15 p.m. ET – we’ll hear the Fed’s decision on short-term rates.

Then, Thursday, we’ll get an auction to reopen a 5-year TIPS, CUSIP 912828K33. It’s possible that this auction will generate a yield somewhere around 0.45% – the highest yield for any 4- to 5-year TIPS in more than five years.

My schedule. I’m working both Wednesday and Thursday and I won’t be able to post much immediately after the inflation report, Fed announcement or the TIPS auction. But I will post another last preview look on the 5-year auction on Wednesday evening.

Here’s the announcement from the US Treasury.

This was the reopening of CUSIP 912828XL9, creating a 9-year, 8-month TIPS with a coupon rate of 0.375%. The resulting real yield to maturity was 0.664%, just barely beating a couple of 2014 auctions to become the highest yield for any 9- to 10-year TIPS auction since May 2011.

Because the yield was higher than the coupon rate, this TIPS auctioned with an adjusted price of $97.64 for $100.34 of value. The adjusted price includes inflation increases since the original auction in July.

Inflation breakeven rate. This 10-year TIPS ended up closing the day with a real yield of 0.65%, compared to a 2.25% yield on a nominal 10-year Treasury. That creates an inflation breakeven rate of 1.60%, which is a bit higher than the norm in recent weeks, indicating that demand is rising for TIPS versus nominal Treasurys. But it is still solidly in the ‘cheap’ range, meaning it is a good buy versus a nominal. If inflation averages more than 1.6% over the next 10 years, this TIPS will outperform the nominal 10-year.

This 5-day chart of the TIP ETF versus IEI (intermediate Treasurys) shows how TIPS have surged against nominal Treasurys. That wasn’t a favorable trend for buyers at today’s auction:

I wasn’t a buyer at today’s auction, although I was watching it with a lot of interest. If the yield looked like it would climb above 0.75%, I might have taken a bite. But I ended up sitting this one out.

December will bring the last TIPS auction of the year, the reopening of a 5-year TIPS on Dec. 17. The current yield of about 0.35% is pretty attractive for a 4-year, 4-month investment. But that yield is pricing in some potential deflation in the near term. It will be one to watch.

I’ll be working Thursday (starting at 6 a.m.!) and I won’t be able to post before the auction and I’ll only be able to post the result – minus analysis – after it closes at 1 p.m. Sorry! But here’s a look ahead at the reopening of CUSIP 912828XL9, creating a 9-year, 8-month TIPS with a coupon rate of 0.375%:

• This TIPS, which trades on the secondary market, is currently trading with a real yield of 0.69%, according to Bloomberg’s Current Yields page. This is down about 7 basis points from where it was last week. It is priced at $97.06 per $100 of value, up from $96.39 last week.
• The Wall Street Journal’s Closing Prices page shows that this TIPS – which matures 2025 Jul 15 – closed today with a real yield of 0.673%.
• The Treasury’s Real Yields Curve page estimates that a full-term 10-year TIPS would have yielded 0.71% at the market close today. A full 10-year TIPS should yield slightly higher than one maturing in 9 years, 8 months.

So the yield trend has been working against investors in the last week. Tomorrow morning, before you make your decision, check that Bloomberg link above and also the price of the TIP ETF. The price rose today to $110.08. If it is rising again tomorrow morning, that will indicate a lower yield at auction.

The 10-year inflation breakeven rate is still sitting at a very low 1.58%, making this TIPS attractive against a traditional Treasury. I suspect there could be fairly strong demand for this TIPS, and that could also lower the yield.

I’ll post the result after the close at 1 p.m. Thursday.