The Treasury just announced that it will be auctioning a new 30-year Treasury Inflation-Protected Security on Feb. 19. This is CUSIP 912810RL4 and the coupon rate and yield to maturity will be determined by the auction.

Here is how this auction is shaping up:

• A 29-year TIPS currently trading on the secondary market today is yielding 0.73% (plus inflation), according to Bloomberg’s Current Yields.
• That same TIPS closed yesterday at with a yield to maturity of 0.723%, according to the Wall Street Journal’s Closing Prices.
• The US Treasury estimated yesterday that a full-term 30-year TIPS would yield 0.75%.

TIPS 30-year yields have been rising a bit in last two weeks, up 23 basis points from the low of 0.52% on Jan. 30. Getting the yield above 0.750% is highly desirable for buyers, because it would lock in a 0.750% coupon rate. Anything slightly below 0.750% would push the coupon rate down to 0.625%.

I generally advise buyers of very-long-term TIPS to hold them in a tax-deferred account, because it takes a coupon rate of about 0.50% to cover the yearly taxes resulting from 2% inflation, which is added to principal and taxed in the current year, but not paid out until maturity, or when the bond is sold.

I also advise that a 30-year TIPS with a coupon rate of 0.75% can be a very dangerous investment if you can’t afford to hold it to maturity. If you are a TIPS buy-and-trader, you could be sitting on a time bomb. At least it will be very volatile on the secondary market. Traders might like that, but it’s a risk when the yield is this low. Only one 30-year TIPS in history has ever had a coupon rate below 0.75% – CUSIP 912810RA8 from February 2013, with a coupon of 0.625%.

Inflation breakeven rate. A 30-year nominal Treasury was yielding 2.57% yesterday, creating a 30-year inflation breakeven rate of 1.82% – a fairly low number that will probably make this TIPS appealing to big investors like pension funds and foreign central banks. The financial markets are pricing in long-term inflation well below 2%. That doesn’t happen often as shown in this chart of 30-year breakevens:

A breakeven rate of around 1.8% gives investors a ‘margin of safety’ because it means that 30-year TIPS yields could rise more slowly than the overall bond market. Say the breakeven rate gradually rises to 2.2%, a fairly common number. If a 30-year nominal Treasury rose 100 basis points to 3.57%, this TIPS would rise only 62 basis points, to 1.37%. But that would still be painful for buy-and-traders.

Here is a chart of all 29- to 30-year TIPS auctions in history, showing that we are currently fairly close to the rock-bottom yields the market seems to bear:

I’ll be checking in on this auction next Thursday morning, and then again after it closes at 1 p.m. on Feb. 19.

Reader maynardGkeynes (I call him MGK for short) posted an interesting question yesterday in the comment section, referring to the fact that an I Bond’s fixed interest rate can get wiped out by a negative inflation-adjusted rate:

Then in way, if I understand correctly, I-bonds are arguably worse than TIPS in deflation. Compare a $1000 TIPS with a $1000 I-Bond, both with a 2% coupon. Assume -5% deflation. The TIPS pays a (2% X $950) = $19; The I-Bond pays $0. Of course, you avoid the immediate $50 principal loss with the I-Bond, but the loss on TIPS is (hopefully) temporary, because the principal loss is recovered when inflation picks up again. However, because you never make up the lost coupon on the I-Bond, the loss is permanent. Does that make sense?

I decided to create an example to play this out, keeping things fairly simple. So we will compare a TIPS and I Bond, each with $1,100 in current principal, and each with a 1% coupon rate, and each dealing with 2% deflation the first year and 2% inflation the next year.

I have no confidence I can do this without making an error, but what the heck, here we go.

The TIPS

• Starting principal value: $1,100.
• Value after year 1 with 2% deflation: $1,078
• Interest from 1% coupon: $10.78
• After year 1, $1,078 principal, plus $10.78 interest paid out = $1,088.78
• Principal value after year 2 with 2% inflation: $1,099.56
• Year 2 interest from 1% coupon: $10.99
• After year 2, $1,099.56 principal, plus $21.77 interest paid out = $1,121.33

The I Bond

• Starting principal value: $1,100
• Value after year 1 with 2% deflation: $1,100
• Fixed rate is wiped out in year 1, so zero additional principal.
• Value after year 2 with 2% inflation and 1% fixed rate: $1,133

The I Bond ends up outperforming the TIPS by 1%, and its resulting principal balance is 3% higher. That’s pretty impressive. In this example, even if the I Bond had a zero percent fixed rate, it would slightly outperform the TIPS with a resulting principal value of $1,122.

If I made any errors in these calculations, or in my logic, give me a critique and we will fix it together.

• Jan. 8, 2016 update:
  

  Buying I Bonds In 2016? One Word Of Advice: Wait!

Buying Series I Savings Bonds from the US Treasury is usually a no-brainer decision. Because individuals are limited to purchasing $10,000 a year in I Bonds from TreasuryDirect (plus $5,000 in paper bonds as a tax refund), many investors jump aboard each January to buy the limit.

I Bonds might seem boring and ultra-conservative, but their status as both a super-safe and inflation-protected investment makes them highly desirable as a way to push money forward into retirement years. A lot of very rich people buy I Bonds to the limit each year and scheme to get that extra $5,000 as a tax refund. Here are some of the reasons why:

• There are no fees, no commissions, no carrying costs.
• The principal balance is 99.999999% safe.
• Interest earned is added to the principal balance until the I Bond is cashed out.
• Federal income taxes are deferred until the I Bond is cashed out.
• There are no state income taxes on interest earned.
• The I Bond can be sold after one year with a minor penalty (3 months’ interest).
• The I Bond can be sold after five years with no penalty.
• The I Bond can be held for 30 years, earning at least the rate of inflation the entire time.

So why wait this year? I Bonds earn interest based on a combination of a fixed rate and an inflation-adjusted rate. Understanding how these rates work is key to timing your purchase of I Bonds in 2015, because unusual factors are at work this year.

The fixed rate is subject to change every May 1 and Nov. 1, but the fixed rate at the time of the purchase stays with that I Bond forever. The fixed rate is currently 0.0%. While the Treasury doesn’t disclose how it determines the fixed rate, it appears likely to remain at 0.0% at the next adjustment on May 1.

The inflation-adjusted rate also changes every May 1 and Nov. 1, but it affects all I Bonds, no matter when they were purchased. The inflation-adjusted rate is currently 1.48% annualized. That means if you purchase an I Bond before May 1, you will receive six months of interest at that 1.48% rate.

The May 1 adjustment to the inflation-adjusted rate will be based on the change in non-seasonally adjusted CPI-U from September 2014 to March 2015. We are three months into this period, and so far the CPI-U index is down 1.36%. That is negative 1.36%. I track these numbers on my Inflation and I Bonds page. Here is the trend:

The trend is pointing toward a negative number for the May 1 inflation-adjusted rate for I Bonds. That has only happened once before in the 17-year history of I Bonds, in May 2009 when the rate dropped to -2.78%.

Good news, bad news. One of the good things about I Bonds is that your accumulated principal can never go down. This isn’t true of Treasury Inflation-Protected Securities, which will lose accumulated principal during times of deflation. If the May 1 adjustment goes negative, these two things will happen:

1. The I Bond’s inflation-adjusted rate will be negative.
2. The I Bond’s fixed rate will remain, but the composite rate will be lowered by the amount of the negative inflation, but not below zero.

So if you are holding I Bonds from years back that have a fixed rate of 1.4%, you could see the fixed rate wiped out by the negative inflation-adjusted rate. But the overall rate will not drop below zero.

Buy an I Bond today? If you buy an I Bond today, you will earn six months of interest at the annualized rate of 1.48%, which combines the fixed rate of 0.0% and the inflation-adjusted rate of 1.48%. Then, after six months, the May 1 adjustment will kick in, and you will (probably) earn 0.0% for six months. Your fixed rate will be unaffected since it is already zero. In effect you will be buying a one-year CD earning 0.74%, which you can then cash in with zero penalty.

Buy an I Bond after May 1 but before Nov. 1? Most likely, you will earn a fixed rate of 0.0% and an inflation-adjusted rate of 0.0% for six months. There really would be no reason to buy I Bonds under that scenario.

It’s possible the Treasury could surprise us and add a small fixed rate – say 0.1% – to make buying I Bonds a little more appealing. I’d say that is unlikely, but if it happened, I would be highly likely to buy I Bonds then, because the fixed rate carries with the investment for 30 years.

(But don’t get your hopes up. The last time the inflation-rate went negative, in May 2009, the Treasury dropped the fixed rate from 0.7% to 0.1%.)

Buy an I Bond after Nov. 1? This looks like the most appealing option. Wait. The fixed rate could rise above 0.0%. The inflation-adjusted rate could rise into a positive number. You could earn something more than 0.0% for six months. Waiting makes the most sense.

Or, this year, buy EE Bonds. If I Bonds continue paying 0.0%, EE Bonds would be an attractive alternative, if you can hold them for 20 years. EE Bonds carry a fixed rate – currently 0.1% – that changes each May 1 and Nov. 1. That looks horrible, but EE Bonds are in effect issued at half their future value. If you hold them 20 years, they will immediately double in price, and that creates an effective interest rate of 3.5%. A 30-year Treasury is yielding only 2.39%.

EE Bonds are a great deal, as long as you can hold them for 20 years. Of course, they are not inflation-protected, so I’d suggest them as an alternative – not a replacement – for I Bonds and TIPS.

Yields on Treasury Inflation-Protected Securities are plummeting, making TIPS you own (and TIPS funds) more valuable, but making TIPS a far less attractive investment in the near term.

US Treasurys of all sorts are booming because of a strong dollar, a new program of quantitative easing bond-buying in Europe, and general weakness in the equity markets. This is a flight to safety. Consider:

• A 10-year US Treasury is yielding about 1.68%.
• A 10-year German bond is yielding 0.30%.
• A 10-year French bond is yielding 0.55%.
• A 10-year Spanish bond is yielding 1.40%.
• A 10-year Italian bond is yielding 1.60%.

So, where is the money going to flow? To higher yield and a stronger currency. Since January 1, the yield on a 10-year TIPS has fallen 38 basis points, from an already-low 0.41% to 0.03% yesterday. The yield on a 5-year TIPS has fallen 44 basis points, from 0.31% to -0.13%.

And while in recent months TIPS were under-performing the overall bond market (making TIPS cheaper as a relative investment), they are now outperforming, as shown in this year-to-date chart:

The TIP ETF, shown in blue, is now outperforming the intermediate Treasury ETF (IEI) and the overall bond market (AGG). This means that inflation breakeven rates are rising, making TIPS more expensive against nominal Treasurys.

Right now the 10-year inflation breakeven rate stands at 1.65%, up 8 basis points from the 1.57% on Jan. 8 when I wrote on this topic.

There’s a 30-year TIPS auction coming up Feb. 19. A 30-year TIPS is currently yielding 0.54%, down 22 basis points since Jan. 1. This low a yield on a 30-year TIPS carries a danger: If held in a taxable account, it could end up cash-flow negative until maturity. The reason? The coupon rate may not cover the current-year taxes owed on inflation adjustments to principal. That makes a 30-year TIPS – at this yield  – a lousy investment in a taxable account.

My thinking is that TIPS aren’t going to be a very attractive buy-and-hold investment in the first half of 2015 – joining a pack of other flawed investments at the moment, I Bonds and bank CDs among them.

The Treasury just announced that its auction of CUSIP 912828H45 – a new 10-year Treasury Inflation-Protected Security – resulted in a yield to maturity of 0.315% and a coupon rate of 0.250%.

Buyers at the auction got a much better yield than looked likely earlier Thursday, when a similar TIPS was trading on the secondary market with a yield of just 0.18%. Later in the morning, however, TIPS yields began climbing. As the auction was closing at 1 p.m., Bloomberg’s survey of dealers predicted a yield of 0.346%.

Because the Treasury sets the coupon rate one notch below the yield, buyers at today’s auction are getting this TIPS at a slight discount to par, about $99.02 per $100 of value.

Inflation breakeven rate. With the 10-year nominal Treasury currently trading at 1.89%, this TIPS is getting a breakeven rate of 1.57%, which is very low by historic standards. This indicates the markets are pricing in very low inflation over the next 10 years. Generally, a breakeven rate below 2% indicates that a 10-year TIPS is ‘cheap’ against a nominal Treasury of the same term. This rate is among the lowest seen in the last five years:

Reaction to the auction.  TIPS yields were fluctuating Thursday, first dropping and then rising.  After the auction, the TIP market is reacting well. This chart shows the day’s activity in the TIP ETF, which holds a broad range of maturities. It started the day up (with yields down) and then moved negative as yields rose. After the auction, the trend was back up, which usually indicates a positive reaction: