Treasury Inflation-Protected Securities

I will be traveling Thursday and so I won’t be able to post any before- or after-thoughts on Thursday’s reopening of CUSIP 912828C99, creating a 4-Year 8-Month Treasury Inflation-Protected Security with a coupon rate of 0.125%.

So let’s take a look at where we stand at 6:05 p.m. Wednesday:

• This TIPS was trading today with a yield to maturity of -0.29%, according to Bloomberg’s Current Yields chart. This is up about 12 basis point from where it was last week.
• The Wall Street Journal’s Closing Prices chart shows that this TIPS maturing April 2019 closed with a yield of -0.308% and a price of about $102 for $100 of value (because of the the coupon rate of 0.125%).
• The Treasury’s Real Yield Curve chart estimates a full 5-year TIPS would yield -0.18%. This estimate isn’t directly comparable with the two quotes above, since a full-term TIPS would yield slightly more than a TIPS with 4-month-shorter term.

So, conditions have improved since I wrote about this auction last week. Last Thursday, the market was signaling a yield of about -0.41% and now -0.29% looks more likely.

With the 5-year nominal Treasury trading today at 1.65%, you’re looking at an inflation breakeven rate of 1.94% for this TIPS. I’d probably take that bet if I were thinking about buying a 5-year Treasury, but maybe not against a 5-year bank CD paying 2.30%, which pushes the breakeven point up to 2.59%.

Honestly, I’m not in the market to buy any of these at the moment. I mean, could interest rates be rising next year? …

Did the Fed give a signal today?

The Wall Street Journal’s Website lead story right now has this headline: ‘Fed Minutes: Rate-Hike Debate Heating Up.’ An excerpt:

Federal Reserve officials debated at their July meeting whether to move sooner than expected to start raising interest rates in light of an improving job market and rising inflation, but decided they needed more evidence before concluding that was the right approach.

The minutes of the meeting, released Wednesday, provide fresh evidence of an intensifying debate inside the central bank about when to respond to a surprisingly swift descent in the unemployment rate and rising consumer prices.

You can read the Fed’s full minutes here. There’s a giant section with the heading: Monetary Policy Normalization, which I can assure you has not appeared in any Fed minutes over the last couple of years. It includes this paragraph:

Meeting participants continued their discussion of issues associated with the eventual normalization of the stance and conduct of monetary policy, consistent with the Committee’s intention to provide additional information to the public later this year, well before most participants anticipate the first steps in reducing policy accommodation to become appropriate.

In other words, the Fed is saying: ‘More to come. Just wait patiently.’ But in fact, the Federal Reserve just signaled that there is more to come, and a reason to wait patiently.

For the Fed, that is a pretty big step.

The US Treasury just formally announced it will reopen CUSIP 912828C99 at auction next Thursday, creating a 4-Year 8-Month Treasury Inflation-Protected Security with a coupon rate of 0.125%.

This TIPS was originally auctioned on April 17, with a yield to maturity of -0.213%, plus inflation. Buyers at that auction paid about $101.87 for $100 of value because of the spread between the yield and the coupon rate.

What can we expect? Since April, yields on TIPS have been sinking, dropping to a low for the year of -0.44% in late May. Recent strength in the overall bond market has again pushed TIPS yields to near their yearly lows.

• Bloomberg’s Current Yields page shows a yield of -0.44% for CUSIP 912828C99 on today’s secondary market.
• The Wall Street Journal’s Closing Prices page shows a closing yield of -0.418% for this TIPS on Wednesday.
• The Treasury’s Real Yields page – which estimates the yield on a full-term 5-year TIPS – shows -0.29%, a fairly wide variance from the other two real-world measurements.

Let’s set aside the Treasury’s number and for now let’s estimate a yield of about -0.420% for next week’s auction. That would mean buyers will pay about $102.50 for $100 of value, plus chip in more than $1 for accrued inflation. That’s pretty pricey for a 0.125% coupon rate.

This chart tracks the longer-term trend for yields on 5-year TIPS, showing the wild swing of more than 500 basis points from the depth of the recession to Fed-induced ultra-low rates of 2012:

It’s impossible to figure what’s ‘normal’ from that chart, but certainly the peak and the nadir can be ruled abnormal. The pre-recession yields above 1% generate nostalgia, but that’s about it. Let’s work on getting above zero.

I personally won’t be participating in next week’s auction, unless yields climb dramatically in the next seven days.

Alternative? I repeat again that buying US Savings I Bonds up to the limit is a much better investment than a 5-year TIPS paying -0.41%. I Bonds currently pay 0.1% above inflation. That is 51 basis points better than a TIPS, and I Bonds are more flexible investments and the interest is tax deferred.

Here is a chart of 4- to 5-year TIPS auctions since 2007. Check it out and tell me if you can figure out what would pass for a ‘normal’ yield in 2014, minus Fed manipulation and simmering world turmoil:

Here is the chart of the day, captured at 9:34 a.m. Eastern time:

Looking at net asset value, the TIP ETF, which holds a broad range of Treasury Inflation-Protected Securities, has performed almost exactly the same as the SPY ETF, which holds the Standard and Poors 500.

• Net asset value for both funds is up about 5% year-to-date as of Aug. 11.
• In addition, the TIP ETF has paid out $1.354 in dividends, an additional return of about 1.2%.
• The SPY ETF has paid out $1.762 in dividends, an additional return of about 0.9%.

You won’t often see two remarkably different assets classes performing in lockstep for such a long period of time. I have said in a previous post that I don’t think this can continue. We should see returns breaking away, especially if stocks continue to rise.

The other possibility is that both assets classes will decline. I think the longer the trend continues upward for both, the more likely a fall for both follows.

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?