Treasury Inflation-Protected Securities

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:

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.