Treasury Inflation-Protected Securities

I noted yesterday that the Treasury has formally announced that it is reopening CUSIP 912810RF7, creating a 29-Year 8-Month TIPS with a coupon rate of 1.375%. The auction is Thursday, June 19 – non-competitive bids (like those made through Treasury Direct) must be received by noon; competitive bids close at 1 p.m.

What can we expect? I hate to call any TIPS auction a ‘stinker’ but this one is looking pretty unattractive.

CUSIP 912810RF7 was created in an auction Feb. 20, with a yield to maturity of 1.495% (plus inflation) and a coupon rate of 1.375%. This was the highest yield for any 29- to 30-year TIPS at auction since June 2011, and buyers got it at a slight discount, about $97.10 per $100 of value. (The discount resulted from the yield being higher than the coupon rate, which is typical in an originating auction.)

Since February, Treasury yields have been slipping, and this TIPS – which trades on the secondary market – has dramatically risen in value. So it is going to be a lot more expensive at next Thursday’s auction. Remember than even a small swing in yield creates a dramatic price change in 30-year Treasurys.

• Bloomberg’s Current Yields Chart this morning is flashing a yield of 1.15% and a price of $105.65 per $100 of value.
• The Wall Street Journal’s Closing Price Chart shows this TIPS closed Thursday with a yield to maturity of 1.123% and a price right around $106.
• The Treasury’s Real Yield Chart shows a 30-year TIPS yielding 1.14%.

My philosophy on TIPS is to buy them and hold to maturity, ignoring market fluctuations in the interim. Although I currently hold a couple of 30-year TIPS (maturing in 2029 and 2041) I am not a big fan of these issues because I am not likely to live long enough to hold them to maturity.

But I would especially object to paying a 6% premium to buy a TIPS that won’t mature until I am 90 years old. That means waiting a lifetime to get the benefit of that 6% premium.

And 1.14% plus inflation is not a particularly attractive yield for a 30-year TIPS, even by today’s very-low-yield standards. The original issue in February at 1.495% was a whopping 35 basis points higher. Over 30 years, that makes a difference.

We’ve had three consecutive 29- to 30-year TIPS auctions with yields of 1.33% or higher. This one looks likely to break that string. With the price at a 6% premium to par, I’ll pass.

Here’s a chart showing details for every 29- to 30-year TIPS auction in history:

Inflation breakeven rate. With the nominal 30-year Treasury trading at 3.41%, this sets up a 30-year inflation breakeven rate of 2.27%, solidly in the neutral zone (neither expensive nor cheap). It is slightly more expensive than the 2.24% breakeven rate created when this TIPS was first auctioned Feb. 20.

Here’s the trend for 30-year TIPS breakevens, showing that his auction falls in the mid-point of values:

View the interactive chart

Beautiful limestone cliffs in southern Corsica, near the city of Bonifacio.

I’ve returned from a couple of weeks vacationing in the Mediterranean island of Corsica. It is French, the birthplace of Napoleon, and amazingly scenic, with high mountains rising out of the sea. There are no ‘easy’ hikes or drives on this island, but the views are fantastic.

Corsica is a small place with French attitudes,  Swiss landscapes and Italian city names. The people are friendly; the food and wine are delicious. It is a motorcyclist’s paradise, but I was driving a Renault Twingo on steep, narrow roads. A great place for vacation — especially since I rarely had access to the Internet, TV or world news. So I came away from Corsica with zero investment ideas.

Now that I’m back, I see that interest rates have climbed slightly in the last couple of weeks. The 10-year Treasury was at 2.54% on May 23, now it is 2.65%. A 10-year TIPS was yielding 0.31% on May 23 and now is 0.43%.

Just as I was leaving, the European Union committed to negative interest rates on excess bank reserves, which sent Euro interest rates tumbling and strengthened the dollar. (Too late for me, unfortunately.) This has caused rates to tumble in Europe, with a Spanish 10-year note now yielding 2.70%, just barely more than a 10-year US Treasury, despite the higher risk. I would expect this to increase demand for US Treasurys, which will keep a lid on yields.

Up next: Reopening of a 30-year TIPS on Thursday, June 19, 2014

I’ll be posting an analysis of this auction tomorrow (I hope), but the Treasury did announce today that is is reopening CUSIP 912810RF7, creating a 29-Year 8-Month TIPS with a coupon rate of 1.375%.

This TIPS was first auctioned Feb. 28, 2014, with a yield to maturity of 1.495%. This TIPS is currently trading on the secondary market with a yield of 1.13%, substantially below the coupon rate and creating a price of about $106 per $100 of value.

More on this issue tomorrow.

The Treasury just announced that the reopening of CUSIP 912828B25 auctioned with a yield to maturity of 0.339%, plus inflation. This is a 9-year, 8-month TIPS with a coupon rate of 0.625%.

That yield, which was expected, is a big drop from the 0.661% this same TIPS yielded when it was first auctioned Jan. 23. It was reopened in March with a yield of 0.659%. Since then, however, Treasurys have rallied and yields have declined.

Buyers at today’s auction paid about $102.70 per $100 of value, but when accrued inflation is added in, the resulting adjusted price is about $103.96. Read the announcement for details.

Inflation breakeven rate. With the nominal 10-year Treasury currently trading at 2.55%, this sets up a 10-year inflation breakeven point of 2.18%. This means that if inflation averages more than 2.18% over the next 10 years, this TIPS will outperform a traditional Treasury. An inflation breakeven point below 2.2% is fairly attractive.

The initial market reaction to the auction was positive, with the TIP ETF getting a strong boost today when the auction results were announced. (A higher price indicates lower yields for TIPS.)

Reaction to the auction. The Wall Street Journal’s Min Zeng reported ‘strong demand‘ for this TIPS.

The highlight of the day was a $13 billion sale of 10-year Treasury Inflation-Protected Securities, known as TIPS, which drew the biggest overall demand in two years. A gauge of demand from foreign investors, known as indirect bid, surged to a record of 66.3%. The results suggested some investors believe inflation in the long term may rise even if price pressures in the U.S. have remained tame amid an uneven pace of economic growth.

“It was very aggressive bidding,” said Marcus Huie, interest-rate strategist at Bank of America Merrill Lynch. “Some investors bet inflation is going to trend up,” especially as comments from some Fed policy makers suggested the central bank would keep interest rates low for longer.

I would note, however, that the ‘aggressive bidding’ ended up with a yield that was actually higher than it had been a week earlier, when this TIPS was trading at 0.291%. This auction went almost exactly as expected.

More from the WSJ report:

Economists at Barclays PLC said the tide of inflation is turning and they expect the U.S. inflation rate to rise to 2.4% by December.

“The last two CPI reports have swayed investor sentiment toward a greater probability of inflation acceleration,” said Keith Price, head of inflation trading at Citigroup Global Markets in New York.

Bloomberg’s Cordell Eddings also noted investor wariness about future inflation.

“Break-evens were cheap going into the auction, and that is why the auction went so well,” said Michael Pond, the New York-based head of global inflation-linked research at the primary dealer Barclays Plc. “Given the realized inflation backdrop, break-evens offer value as realized inflation continues to tick up.”

The U.S. Treasury is reopening CUSIP 912828B25 in an auction today, creating a 9-year, 8-month Treasury Inflation-Protected Security with a coupon rate of 0.625%.

I wrote about this last week and noted that the likely yield to maturity on this TIPS is not going to be very enticing. Here’s an update on market conditions this morning for this TIPS, which trades on the secondary market:

• Bloomberg’s Current Yields is flashing a yield of 0.34% and a price of about $102.65 per $100 of value. (This TIPS carries a coupon rate of 0.625%, so buyers will need to pay up at auction to get the higher coupon rate.)
• The Wall Street Journal’s bond prices chart shows this TIPS closed Wednesday at 0.329% and a price of about $102.80.
• The Treasury’s Daily Yield Curve chart estimates a full-maturity 10-year TIPS would had a yield of 0.36%.
• The TIP ETF, which holds a broad range of maturities, is trading right now at $114.60, down slightly today (meaning yields have risen slightly).

All of that adds up to a wild guess of a yield of about 0.34% at auction today, well below what buyers got when this TIPS first auctioned on Jan. 23 with a yield of 0.661%.

Noncompetitive bidding closes at noon and competitive bidding ends at 1 p.m.

I will post the result of the auction shortly after 1 p.m.