Treasury Inflation-Protected Securities

Did you realize that older I Bonds, issued before May 2008, are worth a lot more than what the Treasury will pay you if you cash them in before maturity? There’s no secondary market, but the fact is: These are gems you should hold.

I wrote this article for SeekingAlpha.com, and talk about which I Bonds you should target if you are fed up with deflation eating into your returns. And which I Bonds you should definitely hold. Hope you will click through and read it there:

Holders Of Older Series I Savings Bonds: Don’t Let Deflation Scare You Into Selling

The Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, ‘headline’ inflation increased 1.4%.

Non-seasonally adjusted inflation – which is used to adjust principal balances on TIPS and set future interest rates on I Bonds – rose 0.2% in January, reaching an inflation index of 236.916. The I Bond variable rate will be set based on inflation from September 2015 to March 2016. So far, with two months remaining, inflation has been running -0.43%, setting up the possibility of a negative composite rate for six months after the next adjustment.

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

Also, I posted a more thorough analysis on SeekingAlpha.com:

January Inflation Report: A Glimmer Of Hope For TIPS And I Bonds?
 

The Treasury just announced that its auction of a new 30-year Treasury Inflation-Protected Security – CUSIP 912810RR1 – resulted in a real yield to maturity (after inflation) of 1.12% and  coupon rate of 1.0%. In addition to that coupon, the TIPS’ principal balance will grow at the rate of inflation.

TIPS yields have been falling over the last 10 days as the stock market has stabilized and the Federal Reserve has taken a cautious approach to future interest rate increases.

Thursday’s yield was about 5 basis points below the yield that looked likely two hours before the auction, and indicates there was plenty of demand for the 30-year issue. The yield was also lower than the 1.2% generated for a 29-year, 4-month TIPS auctioned in October.

The adjusted price for investors was about $96.79 for $100 of par value – caused by the 0.12% spread between the yield and the coupon rate, and the fact that this TIPS will carry an inflation index rate of 0.99835 on the closing date of Feb. 29.

Inflation breakeven rate. With a nominal 30-year Treasury trading right now at 2.64%, this TIPS has an inflation breakeven rate of 1.52%, meaning that if inflation averages more than 1.52% over the next 30 years, this TIPS will outperform a traditional Treasury. That is a very low number, making the TIPS an attractive alternative even with its rather low 1.12% yield.

Reaction to the auction. The TIP ETF had been trading a bit higher all day Thursday, indicating lower yields, and appears to be reacting to the auction with a yawn (except for very quick dip that immediately reversed).

The Treasury should be pleased with the result, with the 30-year real yield coming in about 13 basis points below where it started the year.

CUSIP 912810RR1 is a new 30-year TIPS and today’s auction closes at noon for non-competitive bids and 1 p.m. for competitive bids. The coupon rate and real yield to maturity (after inflation) will be determined by the auction.

Here is how this auction is shaping up at 10:35 a.m. Thursday:

• The Treasury’s Real Yields Curve page estimated Wednesday that a full-term 30-year TIPS would yield 1.18%, plus inflation. This is a very good indication of where the market stood yesterday. It’s worthwhile noting that this yield has climbed 9 basis points in a week, which indicates an upward trend in yield heading to this auction.
• Bloomberg’s Current Yields page shows a real-time quote of 1.13% for a 29-year TIPS currently trading on the secondary market. This number is in line with the Treasury estimate, since a 29-year TIPS should yield slightly less than a 30-year.
• That 29-year TIPS closed yesterday with a real yield of 1.165%, slightly higher than today’s real-time quote.
• The TIP ETF is trading slightly higher this morning at $111.32, up about 0.3% for the day. That also indicates that yields are on the decline this morning.

Given those numbers it looks like this 30-year TIPS auction will generate a yield of 1.18% or less – let’s guess 1.17% – along with a coupon rate of 1.125%. But I’ll remind you that predicting the yield on a new issue is a guessing game. It is new inventor coming on the market – hard to predict.

I’ll be posting again after the auction closes at 1 p.m.

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: