Treasury Inflation-Protected Securities

This is CUSIP 912828N71 and you can read the Treasury announcement here. It’s a new 10-year Treasury Inflation-Protected Security, and that means the both the yield to maturity (after inflation) and the coupon rate will be set by the auction.

With the stock market in turmoil so far in January, the yield on this TIPS offering is likely to be volatile. TIPS usually benefit from a flight to safety during a stock market downdraft, but that hasn’t been happening so far in 2016. Over the last five trading days, the TIP ETF has slightly lost value, while intermediate Treasuries (IEI, shown in red on the graph below) has gained 0.76%.

It’s hard to predict if this trend will continue. Here is what we know at the close of markets on Friday, Jan. 15:

• The best yield predictor for a new-issue TIPS is the Treasury’s Real Yield Curve Rates page, which estimates yields for full-term TIPS. At the close Friday, the Treasury estimated a 10-year TIPS would yield 0.67%, down just 2 basis points from where it opened the year.
• Bloomberg’s Current Yields page shows real-time numbers for the longest-term 10-year TIPS currently trading on the secondary market. Right now its yield stands at 0.64% – but this TIPS matures in July 2025, six months earlier than next week’s new issue. So its yield should be slightly lower.
• You can also look at the Wall Street Journal’s Closing Prices page and see that the TIPS maturing in July 2025 closed unchanged today with a yield of 0.628%.

So if the auction had been held today, this new 10-year TIPS probably would have yielded about 0.670%, generating a coupon rate of 0.625%. That would have been the highest yield – but just slightly – for any 9- to 10-year TIPS since July 2011.

I am especially interested in this auction because I have a TIPS – 912828ET3 – maturing Jan. 15. This was a sweetie, with a coupon rate of 2.0% and a yield of 2.025% after inflation. Inflation was a tame 19.7% over the last 10 years, but I still got about 4% annualized on that investment. (However, a nominal 10-year Treasury was yielding about 4.35% in January 2006, so it would have been the better investment.)

I have other TIPS maturing in April and July this year. At least interest rates appear to be heading higher, if haltingly. A big stock market decline could put an end to that, however.

Conclusion. I would be likely to buy this new TIPS if the yield appears to be climbing above 0.70%.

Here’s a chart of all 9- to 10-year TIPS auctions since January 2009, showing the wide variations in yield, from a high of 2.245% in January 2009 to a low of -0.750% in September 2012. It’s been an amazing seven years.

As an experiment, I wrote this article as an exclusive for the SeekingAlpha.com Website, so I can’t repeat it in full here. But I can say that this is my advice: Don’t buy I Bonds in January. I’d suggest waiting at least until mid-April.

Story summary:

• Rates could rise before the Treasury’s next fixed-rate reset on May 1.
• Threat of deflation could bring a 0.0% return for six months.
• Wait at least until mid-April to buy, or possibly before or right after the Nov. 1 reset.

Read the full article on SeekingAlpha.com

The ‘bond bubble’ didn’t burst in 2015, but it did fizzle a little. Vanguard’s Total Bond Market ETF (BND) started the year at $82.65 and ended at $80.76, a decline of 2.3%. But when you add in dividends the fund paid, it eked out a tiny positive return for the year.

TIPS didn’t fare as well, as inflation breakeven rates fell to extremely low levels against traditional Treasurys. That indicates investors are shunning TIPS, causing yields to rise. The broadly diversified TIPS ETF (TIP) started the year at $112.73 and ended at $109.68, a decline of 2.7%. The fund’s total return after distributions was -1.75%.

At the end of the year, the TIP ETF finally fell below the $110 level, which I have been predicting would be a positive indicator for buy-and-hold-to-maturity TIPS investors. It was as high as $123.15 in December 2012.

What does it mean? The TIPS market is a lot more attractive going into 2016 than it has been for nearly five years. Here’s a rundown of all the TIPS auctions of 2015:

CUSIP 912828H45: 10-year TIPS

First auction, Jan. 22: Auctioned with a yield to maturity (after inflation) of 0.315% and a coupon rate of 0.250%. The inflation breakeven rate was 1.57%.

Reopened, March 19: Auctioned with a real yield to maturity of 0.2%, the lowest yield for an 9- to 10-year TIPS at auction since May 2013. The inflation breakeven rate rose to 1.77%. The auction was a bit of a disappointment, coming one day after Fed chair Janet Yellen declared the Fed would move slowly on increasing short-term interest rates.

Reopened, May 21: Auctioned with a real yield to maturity of 0.358%. The inflation breakeven rate was 1.852%.

CUSIP 912810RL4: 30-year TIPS

First auction, Feb. 19: Auctioned with a coupon rate of 0.750% and a yield to maturity of 0.842%. This was the lowest yield for any 29- to 30-year TIPS auction since February 2013, and the yield of 0.842% was far below the previous year’s 30-year TIPS, which auctioned on Feb. 20, 2014, with a yield of 1.495% and a coupon rate of 1.375%. In my preview article on this auction, I cautioned against this auction, which I predicted could be a ‘time bomb.’

Reopened, June 18. Auctioned with a real yield to maturity of 1.142%. The unadjusted price was $90.16 for $100 of value, because the yield was much higher than the 0.750% coupon rate. This TIPS lost nearly 10% of its value in four months.

Reopened, Oct. 22. Auctioned with a real yield  to maturity of 1.20% and an unadjusted price of $88.91 for $100 of value. The inflation breakeven rate was 1.66%, ultra-low for a 30-year issue.

CUSIP 912828K33, 5-year TIPS

First auction, April 23: Auctioned with a real yield to maturity of -0.335%. The coupon rate was set at 0.125%, the lowest the Treasury allows on a TIPS. This is the lowest yield for any 4- to 5-year TIPS at auction since Dec. 19, 2013. In my preview article, I suggested that investors ‘look for better alternatives.’

Reopened, Aug. 20: Auctioned with a real yield to maturity of 0.305%, a huge jump – 64 basis points – over the April 23 original auction. The unadjusted price was $99.17 for $100 of value and the inflation breakeven rate was a remarkably low 1.16%. In my preview article, I noted this auction was ‘a lot more attractive‘ than April’s.  I was a buyer.

Reopened, Dec. 17: Auctioned with  real yield of 0.472%, the highest for any 4- to 5- year TIPS auction since April 2010. The unadjusted price dropped to $98.52 for $100 of value and the inflation breakeven rate rose to 1.25%. I was a buyer.

CUSIP 912828XL9, 10-year TIPS

First auction, July 23: Auctioned with a coupon rate of 0.375% and a real yield to maturity of 0.491%. The unadjusted price was $98.87 per $100 of value, and the inflation-breakeven rate was 1.79%.

Reopened, Sept. 18: Auctioned with a real yield to maturity of 0.60% and an unadjusted price of $97.86 for $100 of value. The yield of 0.60% was the highest for any 9- to 10- year TIPS since an auction in September 2014. The inflation breakeven point dropped to 1.56%. I was a buyer.

Reopened, Nov. 19: Auctioned with a 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. The unadjusted price was $97.31 per $100, and the inflation breakeven rate was 1.60%.

The trend in inflation

‘Headline’ inflation has remained stubbornly low, held down by a collapse in gasoline prices in 2014. As of November, 12-month inflation was running at 0.5%, but core inflation – which strips out energy and food – has climbed to 2.0% over the last 12 moths. If energy prices rise or even stabilize, we could see higher headline inflation in 2016. Here is the trend over the last year:

A reopening auction today of a 5-year TIPS generated a real yield of 0.472%, the highest for any 4- to 5- year TIPS auction since April 2010. This is CUSIP 912828K33, with a coupon rate of 0.125% and a maturity date of April 15, 2020.

Because the yield was much higher than the coupon rate, this Treasury Inflation-Protected Security auctioned at a discount – the unadjusted price was $98.53 for $100 of value. After accrued inflation-adjusted principal was added in, the adjusted price became about $100.07 for $101.56 of principal.

In other words, if you bought $10,000 of this TIPS at this auction, you paid $10,070 for $10,156 in principal and will earn 0.125% on that principal going forward. The principal will rise and fall with inflation until maturity.

This TIPS has an interesting story, since it originally auctioned in April with a yield to maturity of -0.335%. Buyers at that auction paid $102.52 for $100 of value. That means this TIPS has dropped almost 4% in value since the original auction – a big drop for a 5-year maturity. But it also means buyers today got a good price.

Inflation breakeven rate. A nominal 5-year Treasury is trading right now with a yield of 1.72%, setting up an inflation breakeven rate of 1.25% for this TIPS. If inflation averages more than 1.25% over until April 2020, this TIPS will outperform the nominal Treasury. This rate is very low, indicating the TIPS was ‘cheap’ versus a traditional Treasury.

Reaction to the auction. The TIP ETF has been trading up slightly all morning, and it hasn’t budged with the close of this auction at 1 p.m. That indicates all went as expected.