Treasury Inflation-Protected Securities

The 10-year TIPS quandry: What should the Treasury do in January 2015?

Posted on August 5, 2014 by Tipswatch

UPDATE (Sept 4, 2014): The Treasury has posted its newest preliminary auction schedule, which shows that it will auction a new 10-year TIPS on Jan. 28, 2015, with a maturity date of Jan. 15, 2025. That means there will be two TIPS maturing on that date; the existing one has a coupon rate of 2.375% and sells at a 20% premium to par, so there shouldn’t be too much confusion in the secondary market.

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Awhile back reader Bill noticed something interesting: The Treasury is tentatively scheduled to auction a new 10-year TIPS in mid January, with a maturity date of Jan. 15, 2025. But it already has a TIPS maturing on Jan. 15, 2025: CUSIP 912810FR4, a 20-year, 6-month TIPS that was first issued July 15, 2004.

As far as I can tell, the Treasury has never had two separate TIPS maturing on the same day. I’ve poured over the excellent charts at eyebonds.info (this one in particular) and can’t find any two TIPS that matured on the same day.

After Bill pointed this out, I emailed Treasury Direct with the question: What will the Treasury do in January 2015? In return, I got an email with a chart showing the typical auction schedule and this stock narrative:

The Treasury Department endeavors to be as predictable as possible in the scheduling of auctions to assure that the commercial market works smoothly and efficiently. The following chart illustrates the general pattern of securities offerings. While this chart does provide a reference for when securities are likely to be sold, an offering of securities isn t official until Treasury makes a public announcement (press release) of the details of the issue.

Treasury financing policy decisions and borrowing needs will sometimes change the general pattern of offerings.

In other words … stay tuned. I think it’s possible – maybe most likely – that the Treasury will just create a new 10-year TIPS and live with two maturities on the same date. It would create a little confusion in the secondary market, however, because TIPS are usually listed by maturity date. If anyone has any ideas why this would cause problems, let me know.

But let’s use our imaginations for ‘possibilities’ for January 2015:

Issue a new 10-year TIPS. Follow the auction schedule and live with the dual maturities and possibility of some confusion in the secondary market.
Issue a new 10-year, 6 month TIPS. This would push the maturity to July 2025, which is currently open, but would mess up the scheduled July 2015 auction of another new 10-year. So, not likely.
Issue a new 20-year TIPS. This would be a ‘coup’ – the ultimate surprise. The Treasury issued 20-year TIPS from 2004 to 2009, always in January except for the oddball CUSIP 912810FR4, which was created as a 20-year, 6-month TIPS and then reopened in January 2005. That is the TIPS that matures in January 2025.
Reopen CUSIP 912810FR4. Not likely. This TIPS carries a coupon rate of 2.375% and about a 26% principal increase in accrued inflation. That would be massively expensive for the investor of a TIPS likely to yield around 0.26%. (It is currently trading at about $121 for $100 of value on the secondary market.)
Switch January to a 5-year auction. This doesn’t work because there is already a TIPS maturing January 2020.
Switch January to a 30-year auction. This would work if the Treasury wanted to totally reshuffle its auction lineup. But it would complicate getting two 10-year auctions into one year, each with two reopenings.

Let’s get behind the 20-year! I love the idea of a 20-year TIPS because for the baby-boom investor, a 20-year term still fits in our lifespan. It also substantially raises the yield, from 0.26% to about 0.70% in the current market. (It also substantially raises the volatility for a buy-and-trade investor.)

A 20-year TIPS would allow the Treasury to lock in today’s ultra-low yields for a longer term. So it makes sense for both the Treasury and the investor.

But would the Treasury do this? Why not?

Posted in Investing in TIPS | 2 Comments

Federal Reserve gives savers another slap in the face

Posted on July 31, 2014 by Tipswatch

Ouch. But it’s OK. We’re used to it.

The Federal Reserve’s Open Market Committee on Wednesday issued minutes from its June meeting, with the headline being: ‘Economy is improving, inflation is rising, but Fed stands by ultra-low interest rates well into the future.’

Here’s a summary of key points from the minutes:

The economy. (G)rowth in economic activity rebounded in the second quarter. Labor market conditions improved, with the unemployment rate declining further.
Jobs. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources.
Inflation. Inflation has moved somewhat closer to the Committee’s longer-run objective. Longer-term inflation expectations have remained stable.
Jobs vs. inflation. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat.
Tapering continues. Beginning in August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month rather than $20 billion per month.
The Fed’s massive balance sheet. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
Short-term rates will remain near zero. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. … The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.

There are absolutely no surprises in this. The Federal Reserve will soon end its bond-buying quantitative stimulus, and then the clock will start ticking on the end of its near-zero federal funds rate. Will that rate begin rising in mid-2015, as Fed Chair Janet Yellen hinted earlier this year? We don’t know. The Fed says only that these rates will continue near-zero ‘for a considerable time.’

It is important to note that headline inflation is now running at 2.1%, so it has crossed the Fed’s initial target of of 2% (although it uses a different measure). Unemployment has declined to 6.1%, well below the Fed’s initial target of 6.5%.

And yet short-term interest rates remain near zero, and will continue there for a considerable time. That policy, along with the Fed’s balance sheet of reinvesting Treasuries and mortgage securities, will also tend to hold down long-term interest rates. And that means borrowers gain and savers lose. Thrifty Americans looking for safety can find – at best – interest rates that barely beat inflation, or more likely lag severely below it.

The Wall Street Journal today is speculating that the Fed committee is beginning to feel pressure to raise interest rates, at least symbolically:

Some Fed officials are reluctant to wait too long before acting to raise interest rates. Philadelphia Fed President Charles Plosser dissented from a portion of the Fed’s statement because it failed to reflect “considerable economic progress” officials had witnessed.

The TIPS market, which has been on a tear this year, took a hit Wednesday, as investors speculated that the easy money can’t last forever (plus, let’s face it, they took profits out of overvalued TIPS). Here’s a five-day chart of the TIP ETF, showing the Wednesday reaction:

Michael Ashton, who writes about inflation in his excellent E-piphany blog, is speculating that the Fed is ‘gearing up to stand down’ and that the stock market will be the primary victim when that happens:

It will certainly be interesting to see how long markets can remain levitated when the Fed’s buying ceases completely. Frankly, I am a bit surprised that these valuation levels have persisted even this long, especially in the face of rising global tensions and rising inflation. …

Ashton also makes the case that the Fed is ill-equipped to 1) recognize or 2) act on rising inflation, and that it will very likely overshoot its target. It’s a great piece of writing, so head over there now to check it out.

Posted in Inflation, Investing in TIPS | 5 Comments

10-year TIPS auctions at 0.249%, lowest yield since May 2013

Posted on July 24, 2014 by Tipswatch

The Treasury just announced that a new 10-year Treasury Inflation-Protected Security – CUSIP 912828WU0 – auctioned with a yield to maturity of 0.249% and a coupon rate of 0.125%, the lowest rate the Treasury allows on a TIPS.

Today’s result produced the lowest yield of any 9- to 10-year TIPS auction since May 2013, when a 9-year, 8-month TIPS auctioned at -0.225%. Just seven months ago, a new 10-year TIPS auctioned at 0.661%, about 41 basis points higher.

Because the yield came in just under 0.250%, the Treasury set the coupon to the next lowest 1/8 percentage point, which is 0.125%. That is the rock-bottom coupon rate the Treasury allows on any TIPS.

It also means buyers at today’s auction are getting CUSIP 912828WU0 at a discount, with an adjusted price of $98.9591 per $100 of value, which includes a small amount of interest and inflation adjustment.

Inflation breakeven rate. With the nominal 10-year Treasury currently trading at 2.51%, this sets up an inflation breakeven rate for this TIPS of 2.26%. This means that if inflation runs higher than 2.26% over the next 10 years this TIPS will outperform a traditional Treasury. (Inflation is currently running 2.1%.)

Market reaction. A higher yield looked possible in the hours before the auction, so that indicates a warm reception for this new TIPS. A look at today’s chart for the TIP ETF shows a slight bump (meaning lower yields) immediately after the auction:

Coverage by Reuters noted ‘solid demand’ for inflation protection:

“There’s still pretty solid demand for inflation protection,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., which as one of the Fed’s 22 primary dealers is required to bid in U.S. debt sales. “People are still wanting inflation protection for the long term.”

The Wall Street Journal report noted that Treasury yields have been inching up, but not dramatically. A positive jobs report Thursday indicated that the economy continues to improve, which should mean some pressure on Treasury yields.

Thursday afternoon, the U.S. sold $15 billion in Treasury Inflation Protected Securities, or TIPS, maturing in 10 years. The auction drew solid interest, with enough bids to cover the sale 2.49 times even though the TIPS offered a low 0.249% yield. That is the lowest rate at an auction of its kind since May 2013.

Although inflation in the U.S. remains subdued, there are signs pricing pressure is rising in pockets of the economy. Many analysts say once wages start to increase, that could open the door to broader inflation and help boost the return on TIPS.

Posted in Investing in TIPS | 4 Comments

Checking in on today’s 10-year TIPS auction

Posted on July 24, 2014 by Tipswatch

The auction for CUSIP 912828WU0 – a new 10-year Treasury Inflation-Protected Security – will close today at 1 p.m. Noncompetitive bids – like those submitted through TreasuryDirect – must be place before noon.

Here’s how this auction is shaping up:

Bloomberg’s Current Yields page is flashing a yield of 0.25% for the 10-year TIPS first issued in January. We can assume the yield on a full 10-year TIPS would be a bit higher.
The Wall Street Journal’s closing prices chart shows that the same January TIPS closed yesterday at 0.213%, so it appears yields are on the rise today.
The Treasury’s Real Yields chart pegs a full-term 10-year TIPS at a yield of 0.25%.
The TIP ETF is trading right now at $115.04, down 0.3% on the day, also indicating that yields are on the rise.

From this data, buyers at today’s auction are looking at a yield above 0.25%, possibly up to 0.30%. In fact, 0.30% would not be a surprise, given weakness in the TIPS market today. This should set the coupon rate at 0.250%. A yield below 0.25% would drop the coupon rate – which is set at this initial auction – down to 0.125%.

But as I have noted frequently in the past, it is very difficult to predict precisely the yield on a new TIPS. Surprises can result when new inventory enters the market.

I’ll be posting after 1 p.m. with the auction results, and have more reaction later one.

Posted in Investing in TIPS | Leave a comment

Before you buy that 10-year TIPS … consider an I Bond

Posted on July 22, 2014 by Tipswatch

There’s an auction of a new 10-year Treasury Inflation-Protected Security on Thursday, and it looks like it will generate a yield to maturity of about 0.25% (plus inflation), well below the 0.661% buyers of the last new TIPS got six months ago, in January.

I’ve already noted that this won’t be an attractive auction for CUSIP 912828WU0, and that potential buyers will have a chance to snag it in two reopening auctions later this year, in September and November, when conditions might be more attractive.

There is another alternative: Forget buying this TIPS and buy an I Bond instead, up to the limit.

The way I Bonds work. An I Bond is a security that earns interest based on combining a fixed rate and an inflation rate.

The fixed rate – now 0.10% for as long as you hold the bond, up to 30 years – will never change. So if you bought an I Bond in 2012 with a zero fixed rate, it will continue to have a zero fixed rate. Purchases through Oct. 31, 2014, will have a fixed rate of 0.10%. I Bonds I bought back in 2000 still carry a fixed rate of 3.4% and will continue to do so through 2030.

The inflation-adjusted rate changes each six months to reflect the running rate of inflation. That rate is currently set at 1.84% annualized (for a combined rate of 1.94%). The inflation adjusted rate will change again on Nov. 1, 2014, for all I Bonds, no matter when they were purchased. (However, the effective start date of the new interest rate can vary depending on the month you bought the I Bond, a Treasury oddity. Learn more on my Tracking Inflation and I Bonds page.)

Why they are a great investment.

First, I Bonds are the most conservative and most safe of all investments. Your principal is 99.9999999% safe and it will never decline, ever. If inflation falls to below zero, the inflation-adjusted rate will fall to zero, but not below zero. This is not true of TIPS, where accrued principal declines when deflation strikes. This means I Bonds are a superior investment to TIPS in times of deflation.
I Bonds allow you fantastic flexibility. You can redeem them after one year, costing you three months of interest. Or redeem them after five years and pay no penalty, or just hold them for 30 years and cash out.
I Bonds protect you against unexpected inflation. If inflation in the next 30 years suddenly soars to 7%, 10%, 15%, your principal will increase by that amount because of the inflation-adjusted interest rate.
I Bonds allow you to defer federal income taxes until you redeem them, so you pay zero in taxes until they are sold. This is a big advantage over TIPS, which carry current-year income taxes for both the coupon rate and the inflation adjustment to principal. (Both TIPS and I Bonds are free of state income taxes, an advantage over bank CDs.)
I Bonds are very simple to track as an investment. Just download the Savings Bond Wizard, update your information, and check it a couple times a year. This is another huge advantage over TIPS held at TreasuryDirect, which is a do-it-yourself proposition, even for downloading yearly tax forms. Want to track current value of your TIPS? Open up Excel and get to work. TreasuryDirect is not going to tell you.

The big negative? You can buy only $10,000 per person per year, in a Treasury Direct account, plus an additional $5,000 a year in paper I Bonds through an income tax refund.

Because of these advantages, I Bonds ‘typically’ carried a fixed rate about 1.0% less than the yield-to-maturity of a 10-year TIPS. Today, that spread has dwindled to about 0.15%, and that is the reason that I consider an I Bond more attractive than a 10-year TIPS yielding 0.25%.

A 10-year TIPS is a locked-in investment. You can sell it on the secondary market, but you might face a loss in principal, possibly a dramatic loss. And if held in a taxable account, you will pay ‘phantom’ income taxes on the principal appreciation until maturity.

I Bonds, by contrast, can be sold after one year with a minimal penalty, or after five years with no penalty, or at any other time in future, up to 30 years. All interest is tax deferred. You decide when to cash them in, so you can spread the tax burden across many years.

Or should you wait? The I Bond fixed rate will be re-set on Nov. 1, and it is impossible to predict what the Treasury will do. The fixed rate dropped from 0.2% to 0.1% on May 1, and given current trends in interest rates, it could drop to 0.0% on November 1. But we don’t know, and won’t know.

Unless interest rates begin rising dramatically, though, I can’t see the Treasury raising the I Bond rate above 0.1%.

Posted in I Bond, Investing in TIPS, Savings Bond | 6 Comments