Treasury Inflation-Protected Securities

It seems like the Treasury market has been on a wild ride in 2015, but in reality there’s been a lot of roiling around to get us back – pretty much – where we started the year. That is summed up by this chart, which shows the year-to-date performance of the TIP ETF:

The TIP ETF, which holds a broad range of maturities of Treasury Inflation-Protected Securities, started the year on Jan. 1 at $112.01 and closed Tuesday at $112.05, almost exactly flat. Add in some small distributions and you have a total return right around 1%; Yahoo Finance pegs it at 1.07%.

But as the chart shows, it has been a ‘wild’ ride – at least for a conservative Treasury investment – with the ETF hitting a year-to-date high of $115.63 on Jan. 30 before dipping to $111.51 on March 13, then rising again to $115.49 on April 17, then dipping again to a year-to-date low of $110.75 on June 10.

Keep this in mind: When the price of the ETF rises, TIPS yields are declining. When it drops, TIPS yields are rising. Buy-and-hold investors in TIPS want to see higher yields.

The chart at the right shows  highs and lows for the year for the three TIPS maturities available at auction. What’s interesting here is that yields have fallen on short-term TIPS while rising slightly for the 10-year and more sharply for the 30-year.

At the beginning of the year, there was only a 45-basis-point advantage in buying a 30-year TIPS versus a 5-year TIPS. That was ridiculously low. That spread has now grown to 109 basis points as 30-year yields rise to more reasonable levels.

The TIP ETF, by the way, isn’t very diversified, since there are only 39 TIPS currently trading on the secondary market. Of those, 16 have maturities of 5 years or less. Another 16 have maturities in the 5+ to 15-year range. That leaves only 7 with maturities above 15 years. So the ETF is more influenced by price swings in short-term TIPS, and its price was supported in 2015 as short-term yields fell, balancing off rises in longer-term yields.

When the TIP ETF bottomed out on June 10 at $100.75, the 10-year TIPS was yielding 0.63%. This trend, if it continues, could make TIPS investments interesting again. As yields approach 1% above inflation, the 10-year becomes attractive versus a US Savings I Bond, which currently pays 0.0% above inflation but has tax and maturity advantages.

(However, the I Bond’s fixed rate, which will be updated Nov. 1, tends to rise above 0.0% when the 10-year TIPS yields approaches 1.0%.)

Here is the long-term picture for 10-year TIPS yields. In this historical perspective, a yield of 1% above inflation looks pretty paltry. But it would be a big improvement over the last five years of ultra-depressed yields.

The Treasury just announced that the reopening of CUSIP 912810RL4 – creating a 29-year, 8-month Treasury Inflation-Protected Security – auctioned with a real yield to maturity of 1.142%.

Since this TIPS was created in February with a coupon rate of 0.75%, buyers at today’s auction got it at a substantial discount – an adjusted price of $90.59 for about $100.47 of value. (This TIPS will have an inflation index of 1.00468 on the closing date of June 30.)

On the reverse side, buyers of this same TIPS back in February have seen its market value fall nearly 10% in only four months — an indication of how volatile long-term TIPS can be.

After the auction, the TIPS ETF took a slight bump up in price, indicating a mildly positive market reaction. It has been trading down all day, however.

Inflation breakeven rate. A 30-year nominal Treasury is trading today with a yield of 3.15%, setting up an inflation breakeven rate of 2.01% for this TIPS. That means if inflation averages higher than 2.01% over the next 30 years, this TIPS will outperform an nominal Treasury.

Back in February, this same TIPS auctioned with a breakeven rate of 1.89% — indicating that the market’s inflation expectations are rising. Here is a long-term chart of 30-year breakevens, showing that 2.0% remains on the low side of the scale:

CUSIP 912810RL4 will reopen at auction today, creating a 29-year, 8-month Treasury Inflation-Protected Security. This TIPS has a coupon rate of 0.75%, which was set at the originating auction in February. Noncompetitive bids must be placed by noon; the auction closes at 1 p.m.

Here is how it is shaping up:

• Bloomberg’ Current Yields page shows this TIPS trading today with a yield of 1.14%, about where it was a week ago, and with a price of $90.26 per $100 of value. It is going at a discount because the current yield is higher than the coupon rate of 0.75%.
• The Wall Street Journal’s Closing Prices page shows this TIPS closed Wednesday with a yield of 1.051% and a price around $91.88.
• The Treasury’s Real Yields Curve page estimated that a full-term 30-year TIPS would yield 1.09% at the close Wednesday.
• The TIPS ETF – which holds a broad range of maturities – is trading at 10:30 a.m. at $112.01 this morning, down about 0.5% since Wednesday’s close. This indicates that TIPS yields are rising today, explaining the higher yield indicated by Bloomberg’s real-time quote.

So the market seems to be indicating a yield somewhere near 1.14% and an unadjusted price of about $90.26 per $100 of value. Because this TIPS will have an inflation index of 1.00468 on the June 30 closing date, the adjusted price will be a little higher.

Inflation breakeven rate. With the 30-year nominal Treasury currently yielding 3.13%, the inflation breakeven rate for this TIPS is right at 2% – still low but up from 1.73% in late January. It is low enough to make this TIPS attractive to big money buyers versus a nominal Treasury? Possibly.

Yes or no? I won’t be a buyer, but I am not high on adding 30-year TIPS into my buy-and-hold portfolio. I could (possibly) get interested if yields reach historically ‘normal’ levels of 2% or higher. But not today.

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

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4% in May on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, official inflation was unchanged — 0.0%.

The gasoline index increased sharply in May, rising 10.4% and accounting for most of overall increase. But gasoline prices are still down 25% over the last 12 months. Food prices were unchanged in May, the BLS said, and apparel prices were down 0.5%.

Core inflation – stripping out food and energy – was up 0.1% in May and 1.7% over the last 12 months. This indicates inflation has not yet reached a level (above 2.0%) that would prompt the Federal Reserve to begin raising short-term interest rates.

Holders of TIPS and I Bonds are also interested in non-seasonally adjusted inflation, which is used to determine principal adjustments on TIPS and future interest rates for I Bonds. May’s inflation index was set at 237.805, up 0.51% from April, but essentially unchanged from where it stood in May 2014 — 237.900.

I have updated my Tracking Inflation and I Bonds page to reflect these new numbers. It’s important to note that while I Bonds currently have a negative inflation-adjusted rate through Oct. 31 (-1.60% annualized) that number looks likely to rise into the positive when the new rate sets Nov. 1. Inflation is up 0.71% in the last two months.

Here is the inflation trend over the last 12 months, showing that inflation is definitely rising after months of deflation in late 2014 and early 2015: