Treasury Inflation-Protected Securities

Amid months of turmoil in the bond market, and a lot of scary talk about bonds from investment advisers, yields on Treasury Inflation-Protected Securities have actually declined slightly over the last three months.

Hard to believe, isn’t it? Take a look at the chart for the TIP ETF, in blue, versus Vanguard’s BND ETF (total bond market) since July 1:

After a lot of volatility in the bond market, the price of the TIP ETF has actually increased almost 0.5% since July 1, outperforming the overall bond market. This means TIPS yields have declined over that time.

Here is a summary of how TIPS and Treasurys stand now, versus a year ago:

• 5-year TIPS: Today’s yield is about -0.38%, 44 basis points down from the early-September peak but a whopping 109 basis points higher than a year ago. Today’s inflation breakeven rate of 1.79% is much more attractive than 2.10% a year ago. It’s obvious the bond market is not anticipating near-term inflation.
• 10-year TIPS: Today’s yield is 0.45%, down 47 basis points from the peak but up 99 basis points from a year ago. The inflation breakeven point is 2.18%, down substantially from last year’s 2.42%
• 30-year TIPS: Today’s yield is 1.36%, down 28 basis points from the peak and up 90 basis points from a year ago. The breakeven point is down slightly from a year ago at 2.29%.

What these numbers mean. TIPS yields have declined sharply since the Sept. 18  Federal Reserve decision to back off from tapering its $1 trillion a year bond-buying stimulus program. The early-September peak in yields appeared to be pricing in tapering, and then the bond market was also hit by a weak jobs report (Sept. 13) and a very mild inflation report (Sept. 17).

Nevertheless, TIPS are a much more attractive investment today than they were a year ago, with yields across all maturities up about 100 basis points.  At the same time, TIPS have gotten less expensive versus traditional Treasurys, shown by the lower inflation breakeven rates.

Are TIPS a screaming buy today? No. Are they a horrible investment today? No.

I personally believe Fed tapering is inevitable, and TIPS yields will again rise to more normal levels, in the range of 1% to 2% above inflation. We got very close to 1% above inflation in early September on the 10-year, before the Fed blinked.

A serious government shutdown, while unlikely, would change this equation. Read my April 25 blog: The TIPS earthquake: When did it happen, and why? It documents how the threat of a government shutdown in July 2011, plus a downgrade of US government debt, set off a massive reaction in the TIPS markets, with TIPS yields plummeting into negative territory for the first time in history.

A government shutdown would be ‘good’ for TIPS prices. Let’s hope that doesn’t happen.

The U.S. Treasury just posted the result of today’s auction of CUSIP 912828VM9, a 9-year, 10-month reissue of a TIPS first auctioned on July 18, 2013.  It auctioned with a yield to maturity of 0.5% (plus inflation), the highest yield for any 9- or 10-year TIPS auction since July 2011.

Here is the auction results announcement.

This Treasury Inflation-Protected Security has a coupon rate of 0.3.75%, so that means today’s buyers will get it at a slight discount, about $99.18 per $100 of value, which includes about 78 cents of inflation adjustment accrued since July.

Although the yield of 0.5% was the highest in more than two years, it was lower than the 0.8% that looked likely as recently as last Friday. The Federal Reserve announced Wednesday that it would hold off on tapering its bond-buying stimulus. That sent TIPS yields plummeting, following a weak jobs report last week and a mild inflation report this week.

The yield was slightly higher than the 0.488% projected this morning in a Bloomberg survey of dealers. The initial reaction, indicated by trading in the TIP ETF, looks negative:

Inflation breakeven rate

The 10-year nominal Treasury is trading this afternoon at 2.73%, creating a 10-year inflation breakeven rate of 2.23% for this TIPS. That is up about 10 basis points from the July auction, indicating that TIPS have gotten slightly more expensive versus a traditional Treasury.

What looked to be a very promising TIPS auction – possibly the most attractive in three years – dimmed considerably Wednesday when the Federal Reserve decided to hold off on tapering its bond-buying economic stimulus program. The result: Both the stock market and Treasury market soared. The announcement came at 2 p.m. and the markets moved in lockstep:

The Federal Reserve action to delay tapering sent both the Treasury markets (shown here as the TIP ETF, in blue) and the stock market (S&P 500, in red) soaring.

Big Bad Ben. Fed Chairman Ben Bernanke is making a habit of putting the hex on TIPS auctions — in fact he put the kibosh on this very same TIPS before it was auctioned on July 18, 2013. Back then my headline was, “10-year TIPS auction: We’ve been jawboned“.  A few weeks before that auction, the yield looked likely to hit 0.65%, but Bernanke stepped in on July 10 to sooth the markets with ‘clarifying’ comments about tapering. The result was a 34 basis-point drop in yield in just 5 days. Thanks a lot, Ben.

So now, what? Today’s TIPS auction is a reissue of CUSIP 912828VM9, creating a 9-year, 10-month TIPS with a coupon rate of rate of 0.375%. Since this TIPS now trades on the secondary market, we can get a pretty good idea of its likely yield, which currently is running about 0.480%. It closed yesterday at 0.494%. While that would be the highest 9- or 10-year auction yield in more than two years, it’s still a bit disappointing. Just two weeks ago, the 10-year TIPS yield stood at 0.92%.

That’s a drop of more than 40 basis points in two weeks. It’s enough to give a buyer pause. And in fact, it’s enough to cause me to skip this auction.

Update: This auction went off with a yield of 0.50%.

In my opinion, the Treasury market just got an artificial jolt. But it won’t last because tapering is coming. When it does, there will be another jolt, causing yields to rise. That is my expectation: Higher yields are coming. That is 100%-guaranteed to happen, as long as … the economy continues to improve, the unemployment rate continues falling and Congress and the president don’t shut down the government.

What exactly did the Fed say?

You can read the statement here. What is remarkable is that the Fed sees very little bad news, but it decided to continue bond-buying at the pace of $1 trillion a year. Here is my summary:

• The economy. “Economic activity has been expanding at a moderate pace.”
• Unemployment. “Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated.”
• Inflation. “Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. … The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.”
• The future. “The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline.”
• Tapering? Not yet. “The Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”
• Hidden message for buyers at today’s TIPS auction? “Taken together, these actions should maintain downward pressure on longer-term interest rates …”

Message received.

The Federal Reserve blinked today and delayed any move to cut back on its bond-buying stimulus. The immediate reaction in the TIPS market was a plunge in yield. This development puts in turmoil the likely yield for Thursday’s auction of a reissue of a 10-year Treasury Inflation-Protected Security, CUSIP 912828VM9.

The yield on a nominal 10-year Treasury immediately dropped about 10 basis points. At 2:30 p.m., Bloomberg’s real-time data for a 10-year TIPS show a yield of 0.54%, down 16 basis points from yesterday’s close of 0.70%.

The dramatic move is shown in this inter-day chart for the TIP ETF:

More details to come as we get more information.

Beautiful Fort Anne, built in 1797 to protect the harbor of Annapolis Royal, Nova Scotia.

I’ve been away on vacation in Nova Scotia the last two weeks, away from a computer and (usually) far from e-mail or business news. So we have some catching up to do … plus there is a 10-year TIPS reissue auction coming up this week … and a new inflation report.

Bump in yields

When I left on August 30, the 10-year TIPS yield stood at 0.68%, plus inflation. Today it is about 0.76%, so it’s seen a bit of a boost. But within those two weeks, on September 5, it high a multi-year high of 0.92%. The inflation breakeven rate for a 10-year TIPS today stands at 2.12%, about where it was two weeks ago.

Today’s inflation report

The U.S. ‘headline’ inflation rate – technically known as the seasonally-adjusted Consumer Price Index for All Urban Consumers (CPI-U) – increased just 0.1% in August and is up a meager 1.5% over the last 12 months. The weak number was primarily caused by a 0.1% drop in the price of gasoline, and a 0.3% decline in energy overall. Food was up just 0.1%. Medical care services, however, were up a sharp 0.7%.

Holders of TIPS and I Bonds care most about the non-seasonally adjusted increase, which is used to adjust the principal on TIPS and set future rates for I Bonds. That increase was also 0.1% in August, and 1.5% over the last 12 months.

‘Core’ inflation, which strips out energy and food, was also up 0.1% in August and up 1.8% over the last 12 months, below the Federal Reserve’s target of 2%.

Today’s inflation report could tip the balance to cause the Federal Reserve to back away from plans to taper its QE3 purchases of Treasuries. That announcement could come Wednesday after a Federal Reserve meeting.

The early reaction to these numbers has TIPS yields falling today, with the 10-year TIPS trading at 0.70%, down 6 basis points from yesterday. The TIP ETF is up about 0.25% in early trading.

10-year TIPS reissue will auction Thursday

This is a reissue of CUSIP 912828VM9, which first auctioned July 18, 2013, with a coupon rate of 0.375% and a yield to maturity of 0.384%. That means Thursday’s auction will be going off at a discount, about $96.19 for $100 of value. But this TIPS also carries accrued interest (from inflation adjustments) of about 0.3%, which will also factor into the price.

I was a buyer of this TIPS back in July, and it is certainly more attractive now that the yield has risen more than 30 basis points.

Wednesday’s Fed announcement could roil the markets, so keep an eye out for reaction. If the Fed goes ahead and launches tapering, TIPS yields could rise substantially (although I theorize this has already been priced in).  If Fed decides to hold off on tapering, expect yields to decline.

More on this later. It’s good to be back.