Treasury Inflation-Protected Securities

In an auction that capped two days of turmoil in the market for Treasury Inflation-Protected Securities, the Treasury just announced that CUSIP 912828B25 was reopened with a yield to maturity of 0.659% plus inflation, just under the 0.661% this TIPS generated at its initial auction on Jan. 23.

View the Treasury announcement.

This is a 9-year, 10-month TIPS with a coupon rate of 0.625%, meaning today’s buyers are getting it at a slight discount, with an adjusted price of about $99.91 per $100 of value, including in a small amount of inflation appreciation since January.

Although this auction broke a string of of eight consecutive 9- or 10-year TIPS auctions with higher yields, buyers today benefited from an upswing in TIPS yields this week, in reaction to the Federal Reserve’s cloudy message on future interest rates. On Monday, this same TIPS closed on the secondary market at 0.493%. That’s a jump of 17 basis points in four days.

Inflation breakeven rate. The nominal 10-year Treasury closed Wednesday with a yield of 2.78%, and has barely budged this afternoon at 2.77%. The 2.77% yield sets up a 10-year inflation breakeven rate of 2.11%. This is a fairly attractive number, and down slightly from the 2.12% of the January auction. It means that if inflation averages more than 2.11% over the next 10 years, this TIPS will outperform a traditional Treasury.

Reaction to the auction. The Wall Street Journal noted ‘lackluster demand’ for TIPS at this auction, ‘reflecting uncertainty about the economy’s ability to generate inflation in the coming years.’ From the report:

After starting the year strong, TIPS have had a tough time in March, handing owners a 0.7% total loss so far through Wednesday. TIPS are a hard sell these days, with the combination of little inflation in the current economy and the Federal Reserve cutting down on stimulus.

The Bloomberg report also noted pointed at low inflation as the cause for the ‘below-average demand’ at this auction:

“It’s a negative environment for inflation right now,” said Aaron Kohli, an interest-rate strategist at primary dealer in New York BNP Paribas SA. … “Investors are not worried about inflation anytime soon. Any risk premium that had been built in is just going away. If the Fed is on a path to taper when inflation is low, it makes no sense to build in a risk premium.”

It looks like today’s reopening of CUSIP 912828B25, creating a 9-year, 10-month TIPS, could auction with a yield to maturity above 0.60%, much higher than looked likely just a few days ago.

Bloomberg’s Current Rates site is flashing a yield of 0.63% for this TIPS, a nice tick up from Wednesday’s closing price of 0.571%. On Monday, it closed at 0.493%.

This uptick in yields results from fears that the Federal Reserve will (eventually) begin raising short-term interest rates. Which of course it will. But when? The market seems to believe the rise could begin early instead of later in 2015.

If the yield of 0.63% holds for CUSIP 912828B25, buyers should be paying close to par value for this TIPS, which has a coupon rate of 0.625% and almost no inflation appreciation since the initial January auction.

Wednesday was certainly an interesting auction’s eve. On the day before the Treasury is reopening CUSIP 912828B25 – a 10-year Treasury Inflation-Protected Security – at auction, the Federal Reserve today issued a statement that certainly said nothing dire … but the market reacted.

The TIPS market was shaken when the statement was released at 2 p.m., as you can see from this chart, showing the one-day price of the TIP ETF, which holds a broad range of maturities:

So what did the Fed say? The big news, as reported in this Wall Street Journal report, is that the Fed affirmed that it would continue to hold short-term interest rates low well into the future. It also said, as expected, that it would continue to lower its bond-buying stimulus by $10 billion in April.

All of this appears to be good news for the bond market. So why the hit to TIPS, which were slammed harder that the overall bond market, the overall Treasury market, and even harder than long-term Treasuries?

Michael Ashton, who writes the E-piphany blog focusing on inflation, offers this explanation:

TIPS were mainly under pressure because there is an auction scheduled for tomorrow and it was dangerous to set up prior to the Fed meeting, not because there was something secretly hawkish about the Fed’s statement. Indeed, they took pains to say that “a highly accommodative stance of monetary policy remains appropriate” …

If you are searching for secret code words from the Fed, you can read its full statement. In very brief summary, it says:

1. The economy has slowed (slightly) because of the harsh winter.
2. Inflation is running below the Fed’s long-term objective. “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance.”
3. The Fed will continue tapering its bond-buying stimulus program in April, but it will still be buying $50 billion in bonds that month.
4. The Fed said it will continue to keep short-term interest rates very low, noting “that a highly accommodative stance of monetary policy remains appropriate.”
5. And well, forget about the numbers: “Even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

So there you go. If anything, this Fed policy is encouraging – practically begging for – higher inflation, and that should cause demand for TIPS to rise and yields fall. But the opposite happened Wednesday.

It will be interesting to see what happens Thursday morning. If TIPS continue on a sharp decline – meaning yields rise – Thursday’s auction could get a lot more desirable.

As of the market close Wednesday, CUSIP 912828B25 (the TIPS being reopened Thursday) was trading on the secondary market with a yield of 0.571%, substantially higher than Wednesday’s close of 0.480%, but still well below the 0.661% that this same TIPS drew at its original auction Jan. 23.

Keep an eye out in the morning.

Later today, the U.S. Treasury will formally announce it will reopen CUSIP 912828B25, a 10-year Treasury Inflation-Protected Security, in an auction on Thursday, March 20. This TIPS originally auctioned Jan. 23, 2014, with  a coupon rate of 0.625% and a yield to maturity of 0.661%, plus inflation.

Update: Here’s the announcement.

So, what can we expect from this 9-year, 10-month TIPS?  If the auction were today, the yield to maturity might be around 0.55%, a drop of 7 basis points since the January auction. That means buyers would have to pay up a little to snag this TIPS, around $100.30 for  $100 of value.

But a lot can happen in a week. Here are some data sources to check before the auction:

• The Treasury’s Daily Real Yield Curve Rates, which right now are indicating a yield of 0.54% for a 10-year TIPS.
• Bloomberg’s Current Yields, which reflects current trading but can be a little misleading. At this moment, it shows CUSIP 912828B25 trading at 0.55%.
• The Wall Street Journal’s closing price list for TIPS, which shows that the TIPS maturing 2024 Jan 15 closed Wednesday at 0.523%.
• I’d also recommend using the Treasury’s Yield Curve site to track the yield of the nominal 10-year Treasury, which is currently at 2.73%. The TIPS yield is likely to rise and fall with that number over the next week.

If next Thursday’s auction yield fails to exceed 0.661%, it will break a string of eight consecutive 9- or 10-year TIPS auctions that have resulted in a higher yield. Here is a history of 10-year TIPS auctions going back to 2009:

Although bond yields were expected to rise in 2014, the opposite has happened, thanks to some shakiness in the stock market and worries over Russia’s incursion into Crimea. All Treasurys, including TIPS, benefit with the ‘flight to safety’ that inevitably follows stock-market hiccups. The TIP ETF is up almost 2% since Jan. 1, even as inflation remains tame.

It’s also significant that TIPS have been out-performing Treasuries of similar terms. Take a look at this year-to-date chart for the TIP ETF versus IEI, an ETF holding intermediate-term Treasuries and having a similar duration:

When you see this happen, it means the inflation breakeven rate is climbing, and TIPS are getting more expensive versus traditional Treasuries.

If next Thursday’s auction goes off at 0.55%, it would create an inflation breakeven rate of 2.18%, versus 2.12% when the TIPS first auctioned in January. Still on the relatively cheap side, but keep an eye on the 10-year Treasury over the next week.