Treasury Inflation-Protected Securities

The Treasury just announced that a new 10-year Treasury Inflation-Protected Security auctioned today with a coupon rate of 0.375% and a real yield (after inflation) to maturity of 0.491%. This is CUSIP 912828XL9 and it matures July 15, 2025.

Because the auction yield dipped below 0.5%, the Treasury pegged the coupon rate on this TIPS to the next 1/8 percentage point below, explaining the 0.375% number. Therefore, investors bought it at a discount – an unadjusted price of $98.87 per $100 of par value. After an inflation index of 1.00262 is added in, the adjusted price rises to $99.13 for about $100.26 of adjusted value on the issue date of July 31.

Today’s yield was slightly lower than the market was indicating yesterday, but this was still the highest yield for any 9- to 10-year TIPS auction since November 2014.

Inflation-breakeven rate. A nominal 10-year Treasury is trading today with a yield of 2.29%, setting up an inflation-breakeven rate of 1.79%, which remains solidly in the ‘cheap’ range for a 10-year TIPS. This means if inflation averages more than 1.79% over the next 10 years, this TIPS will outperform a traditional Treasury.

Here is a chart of 10-year TIPS breakevens going back to May 2009:

Reaction to the auction. The TIP ETF – which holds a broad range of maturities – had been wobbling most of the morning, first down and then up slightly as the auction approached. After the auction close at 1 p.m., it continued trading slightly higher, indicating lower yields. Overall, the reaction is muted, indicating a well-received auction.

Noncompetitive bids need to be placed by noon today if you are interested in investing in CUSIP 912828XL9, a new 10-year Treasury Inflation-Protected Security. This is a decently attractive offering, so it’s worth a look. The coupon rate and real yield to maturity (after inflation) will be set at the auction.

What can we say at 9:45 a.m. on auction day?

• The Treasury’s Real Yields Curve page estimates that a full-term 10-year TIPS would have closed yesterday with a yield of 0.53%. If that yield holds at today’s auction, this TIPS would get a coupon rate of 0.50% and adjusted price should be very close to the par value. A yield below 0.50% would result in a coupon rate of 0.375%, and this TIPS might be priced at a slight discount.
• The Wall Street Journal’s Closing Prices page shows that a TIPS maturing in January 2015 – the closest to a full-term 10-year on the secondary market – closed yesterday with a yield to maturity of 0.482%.
• Bloomberg’s Current Prices page shows that same TIPS trading this morning with a yield of 0.51%.
• The TIP ETF is trading down (slightly) this morning, just after the market opening. That indicates a slight rise in yields. If it stays negative, this new TIPS will likely come in with a yield above 0.50%.

The 10-year nominal Treasury is trading this morning at 2.33%, setting up a decent inflation breakeven rate of about 1.8% — meaning that inflation averages more than 1.8% over the next 10 years, this TIPS will outperform a nominal Treasury.

Yes or no? I’ve decided to make a small investment in this TIPS, mainly to fill a 2025 spot in my TIPS ladder. Because it’s a small investment, if yields rise I can add to it later this year when the TIPS reopens in September and November.

I’ll be posting again with the auction results after 1 p.m.

The US Treasury announced yesterday it will be creating a new 10-year Treasury Inflation-Protected Security at an auction next Thursday – July 23, 2015. This is CUSIP 912828XL9 and the coupon rate and real yield to maturity will be set at auction.

I consider the 10-year maturity the ‘sweet spot’ for buy-and-hold TIPS investing, since it fits into most people’s life expectancy (versus the 30-year) and gets a bump in yield (versus the 5-year). The Treasury must agree, since it creates two new 10-year TIPS each year and reopens each twice, for a total of six 9- to 10-year TIPS auctions a year.

And this auction comes at an interesting time. Things in Europe and China seem to be settling down, causing the ‘flight to safety’ to Treasurys to wane. That means yields have been rising, although not dramatically. There has been a lot of volatility this year in the 10-year TIPS yield, but yields have been returning to their 2015 highs:

Here’s what we can say right now about next Thursday’s auction:

• Bloomberg’s Current Yields page shows the most recent 10-year TIPS (CUSIP
  912828H45, issued in January) is trading on the secondary market with a real yield to maturity of 0.49%.
• The Wall Street Journal’s Closing Prices page shows that same TIPS closed yesterday with a yield of 0.479%.
• The Treasury’s Real Yields page estimates that a full-term 10-year TIPS would have  closed yesterday at 0.52%. That number is in line with the Bloomberg and Wall Street Journal numbers, since a full-term TIPS should yield slightly higher.

So at this point we’re looking at a 10-year TIPS with a real yield (after inflation) to maturity of around 0.52% and possibly a coupon rate of 0.50%. But a lot can happen in a week, especially with the market volatility we have seen around the world.

Is 0.52% an attractive yield? Not really, but some might consider it acceptable. If you look back at the last 15 auctions of 9- to 10-year TIPS, going back to January 2013, the distribution of yield looks like this:

• 5 had a yield of 0.500% or higher, the highest was 0.661% in January 2014.
• 7 had a yield between 0.0 and 0.499%
• 3 had a negative yield, the lowest was -0.630% in January 2013.

So this auction is shaping up as ‘upper middle of the recent pack.’ Not exciting, but also not horribly unattractive.

The questions. Where do you think interest rates are headed? Do you see the Federal Reserve stepping up later this to raise short-term rates? Even if that happens, do you see the Fed action having much effect on longer-term rates? And will the Fed make just a token move higher will no followup? Will interest rates begin rising in Europe, making US Treasurys less desirable, causing yields to rise? Or will market disruptions cause a flight to safety and send TIPS yields plummeting?

My expectation is that yes, the Fed will finally raise short-term rates later this year. It has given that signal multiple times. But unless inflation begins rising dramatically, the Fed move will be token. Rates won’t rise by much.

A final thing to remember: This 10-year TIPS will reopen at auction in September and November, giving investors two more shots to jump aboard. At this point, I probably won’t be a buyer, but things might change in the next few days.

Here’s a look at all 9- to 10-year TIPS auctions going back to January 2010:

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.