Treasury Inflation-Protected Securities

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.

I am at work today so I can only post the facts:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in October on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 0.2% before seasonal adjustment.

Non-seasonally adjusted inflation – which is used to adjust the principal balance of Treasury Inflation-Protected Securities and set future interest rates on US Savings I Bonds – decreased a slight 0.04% in October, and was up 0.2% over the last 12 months.

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

The US Treasury just announced that it will reopen CUSIP 912828XL9 at auction on Nov. 19, creating a 9-year, 8-month Treasury Inflation-Protected Security. This TIPS, which first auctioned on July 23, carries a coupon rate of 0.375%.

It will be going off at a discount, because yields on 10-year TIPS have risen a bit in recent months. Here is what we know from the secondary-market trading in CUSIP 912828XL9:

• Bloomberg’s Current Yields page shows it trading this morning with a real yield to maturity of 0.76% and a price of about $96.39 for $100 of value.
• The Wall Street Journal’s Closing Prices page shows that this TIPS – which matures 2025 Jul 15 – closed yesterday with a real yield of 0.725% and an ask price of about $96.75 per $100.
• The Treasury’s Real Yields Curve page estimates that a full-term 10-year TIPS would have closed yesterday with a yield of 0.77%.

Those numbers indicate that – a week out from the auction – this TIPS is yielding around 0.765%, plus inflation, resulting in a cost of around $96.50 for $100 of a value. But a lot can happen in a week. If you are interested in this TIPS, you should watch the three links above to judge its current value as Nov. 19 approaches.

Also, note that this TIPS will carry an inflation index of 1.00343 at the settlement date – Nov. 30. That will slightly increase an investor’s cost, but also slightly increase the principal purchased, since the TIPS will carry accrued inflation.

Yield milestone? If the yield of 0.75% holds through the auction, this TIPS will have the highest yield resulting from any 9- to 10-year auction since May 2011. That’s more than four years. I suspect there will be a lot of interest in this auction.

Inflation breakeven rate. A nominal 10-year Treasury is trading today with a yield of 2.32%, creating an inflation breakeven rate of 1.57% if this TIPS goes off at 0.75%. I consider this ultra low. It means this TIPS will outperform a nominal Treasury if inflation averages more than 1.57% over the next 10 years.

Investors are pricing in very low inflation, as shown in this chart, which tracks the 10-year inflation breakeven rate over the last five years:

You can see how rarely implied inflation drops below 1.6%. TIPS are a good buy when that happens, at least versus a nominal Treasury.

Here’s a chart of every 9- to 10-year TIPS auction since January 2009, showing the huge dip in yield beginning in mid-2011, then gradually reversing in 2013 and beyond.

I am not invested in TIPS mutual funds; my preferred strategy is to buy TIPS at auction and hold them to maturity. But I do follow the TIP ETF to check on the overall trend in TIPS, and I have said for a long time that TIPS values would be returning to a more ‘normal’ level when the TIP ETF dropped below $110.

That has happened a few times in the past five years, and it happened again this morning. Here is the five-year chart:

A lot has happened over those five years, as is reflected in the chart. In mid 2011, the Treasury began an aggressive bond-buying program, which lowered long-term yields and spurred fears of inflation. The value of Treasury Inflation-Protected Securities soared and real yields plummeted well below 0.0%. TIPS were in high demand.

Then, in June 2013, Fed Chairman Ben Bernanke announced a ‘tapering’ of the bond-buying, and inflation fears were doused. The Consumer Price Index began sliding down as oil prices began declining. TIPS were no longer in high demand. The TIP ETF lost about 8.5% of its value in 2013 – a shock for some investors who thought it was a bulletproof investment.

So where do we stand today? Of the 39 TIPS currently trading in the secondary market, only 3 still have yields negative to inflation. That is a far cry from April 12, 2013, when 35 of the 39 TIPS were trading with negative yields, all the way up to a TIP maturing in April 2032.

TIPS were a horrible investment in April 2013. They are a lot more attractive in November 2015, even after a year of zero inflation.

• A 5-year TIPS – if auctioned today – would yield 0.42% above inflation, according the Treasury’s Real Yield Curve estimates.
• A 10-year TIPS would yield 0.71%.
• A 30-year TIPS would yield 1.27%.

And TIPS remain cheap when measured against traditional Treasurys. The 10-year inflation breakeven rate, shown in the chart below, is currently running about 1.57%. Investors are pricing in very low expected inflation. Generally when the breakeven rate falls below 2%, TIPS are a bargain. This is well below 2%.

I am not recommending dumping your money into TIPS mutual funds, but I think they are a much safer investment now than they were in 2013. And I think upcoming TIPS auctions will be worth watching.

The next one is Thursday, Nov. 19, the reopening of a 10-year TIPS, CUSIP 912828XL9. It will be going off at a big discount. More on that later.

I wrote yesterday about how the lowly Series EE Savings Bond is actually a pretty attractive investment in today’s interest-rate environment, if held for 20 years. I didn’t expect many people to agree with me. So far, everyone seems to be much more interested in the new I Bond with a fixed rate of 0.1%. That’s OK, I am buying that I Bond, too.

But there’s a real possibility that the EE Bond will outperform the I Bond over the next 20 years, because if you pair off the two investments, the I Bond gets an inflation-breakeven rate of 3.4%. It will under-perform against the EE if inflation averages less than 3.4%.

I created this chart to show how an EE Bond will perform against other very safe investments, in different inflation environments:

The blue area shows that the EE Bond outperforms all the other options up to average inflation of 2.5%. At that point and above, the 20-year TIPS outperforms all the other investments. The EE Bond outperforms the I Bond up to an inflation rate of 3.0%, and just barely under-performs at 3.5%.

The 20-year Treasury is the big loser in this chart. It under-performs at all inflation rates. The I Bond is never a big loser or a big winner; it can’t outperform a 20-year TIPS yielding 0.92%, but it does offer tax advantages and a flexible maturity.