Treasury Inflation-Protected Securities

Well, it’s actually a reopening of CUSIP 912810RA8, so buyers will be getting a 29-year, 4-month TIPS with a coupon rate of 0.625%. It will be going off at a huge discount, showing how volatile 30-year Treasurys can be.

Right now, it’s looking like the yield will come in at 1.38%, plus inflation. That’s where this TIPS was trading on the secondary market Monday. Today’s rather weak jobs report – read the Reuters report – could give TIPS and Treasurys a boost, pushing the yield lower.

That 1.38% yield means this TIPS will be priced around $81.25 for $100 of value. That’s a fall of 18.7% since the original issue in February.

Does it make this issue attractive? Somewhat. Getting a TIPS with a yield above 1% has been very rare in the last three years. I think I counted 26 of the last 27 TIPS auctions with a yield below 1% – the only exception was when this same TIPS was reopened in June at 1.42%.

But the June (1.42%) to October (1.38%) trend shows that TIPS yields have stalled after the strong move upward beginning in May 2013. So the price buyers pay might actually be higher Thursday than it was in June.

With a 30-year nominal Treasury trading at 3.68%, the inflation breakeven rate for this TIPS stands at 2.3%, not particularly cheap. That means if inflation averages more than 2.3% over the next 30 years, this TIPS will outperform the traditional Treasury.

I do think inflation is likely to be higher than 2.3%, and I’d definitely buy this TIPS over a 30-year Treasury, just to get the inflation protection.

The key issue is: Will rates be rising by mid-2014? I suspect they will be, and so I’m going to be patient. The Federal Reserve can’t continue bond-buying forever, can it? (Ummm …) But the bigger problem is a dysfunctional U.S. government that can’t make even short-term budget decisions, let alone addressing giant spending issues arising in the next 25 years.

Inflation is a definite threat for the future.

Edvard Munch painted four versions of The Scream, plus the lithograph shown above.

One of the side effects of the U.S. government fiscal circus of the last few weeks is that  Federal Reserve officials must be sitting on the sidelines, mouths open in horror. Sort of like Edvard Munch’s famous paintings and lithographs. What are they doing?

So, today, the Wall Street Journal’s ‘Heard of the Street’ column (‘Shutting the Fed’s Taper Plans‘) confidently predicted a complete shutdown of taper talk until the federal government comes up with some sort of consensus on the budget and debt limit.

Up until Sept. 19, the markets had been betting the Federal Reserve would begin a gradual tapering of its bond-buying economic stimulus program. But on that day, the Fed decided to put taper on hold. That was probably a wise move, given the huge disruptions this month caused by the government shutdown and debt-ceiling brinksmanship.

Now, with only a short-term agreement in place, Congress has effectively given the Fed a free pass to continue the bond buying into 2014. The Wall Street Journal notes:

If the numbers look good, Fed policy makers at their December meeting might feel justified in scaling back the central bank’s bond-buying program. But that would ignore one crucial consideration: With the budget deal funding federal agencies only through Jan. 15, and raising the debt ceiling only through Feb. 7, another battle could be brewing.

The Fed will probably want to avoid doing anything to discomfit markets until the risk of another showdown has passed. That pushes the likely timing for starting the tapering process to the Fed’s March meeting …

What does this mean for holders and buyers of Treasury Inflation-Protected Securities? I think we can see yields lingering in this current range, around 0.40% for a 10-year TIPS and 1.35% for a 30-year TIPS, well into next year. Yields have fallen more than 50 basis points since an early-September peak. We probably won’t get that 50 back in the near term, and I don’t think we’ll see much of a fall from here, if the economy remains stable.

We don’t know the answer to this question because of the partial U.S. government shutdown. The Bureau of Labor Statistics was due to release its September inflation report today at 8:30 a.m., but it is has not been gathering data since Sept. 30. So … no report. Instead we get this notice on the BLS site:

This website is currently not being updated due to the suspension of Federal government services. The last update to the site was Monday, September 30. During the shutdown period BLS will not collect data, issue reports, or respond to public inquiries. Updates to the site will start again when the Federal government resumes operations. Revised schedules will be issued as they become available.

Update: The BLS now says it will release the CPI report on Wednesday, Oct. 30. Here is the update – 0.2% inflation in September.

This inflation number, known as the Consumer Price Index, is important. For example, the September inflation rate is the final piece used by the Social Security Administration to determine its annual cost-of-living adjustment for beneficiaries. Of course, CPI-U is also used to set the daily principal adjustment for Treasury Inflation-Protected Securities, and goes into the data determining the future interest rate paid by US Savings I Bonds.

So now what? The Wall Street Journal reports today that the Treasury will now be forced to generate its own data. The figure will be based on the last available 12-month change in CPI, which was a meager 1.5% (one of the lowest of recent years). From a Treasury document:

(iv) If the CPI for a particular month is not reported by the last day of the following month, we will announce an index number based on the last available twelve-month change in the CPI. We will base our calculations of our payment obligations that rely on that month’s CPI on the index number we announce.

(The principal adjustment for TIPS has already been established through Oct. 31, so there is no immediate effect from the delayed data. For example, here are the data for the 30-year TIPS being reissued on Oct. 24.)

The Journal also notes that the BLS has already gathered the September data, so once the shutdown ends, it can issue the report very quickly. But the October report is in jeopardy because the agency has not been gathering data for more than half a month.

The U.S. Treasury will formally announce this Thursday, but it has already indicated it will reopen CUSIP 912810RA8 at auction on Oct. 24, creating a 29-year, 4-month Treasury Inflation-Protected Security.

Update: Here is the Treasury announcement

This will be an especially interesting auction because the announcement comes on the very day the Treasury predicts it will hit its debt ceiling. If this political crisis continues on for days or even a week beyond Oct. 17, it could roil Treasury, stock and bond markets. But I doubt that will happen.

This auction will also be interesting because buyers will be getting this TIPS at a huge discount from its original price on Feb. 21, when it auctioned with a coupon rate of 0.625%, and a yield to maturity of 0.639%. CUSIP 912810RA8 is now trading with a yield of about 1.4% and a price of about $81 for $100 of value. (The price buyers pay will also reflect about $1.70 in inflation adjustment since the February auction.)

A TIPS with a yield well above 1% (plus inflation) has been a rare thing recently. The only other auction with a yield above 1% was for this same TIPS in a June reissue, which netted a nice yield of 1.42%.

TIPS were under attack in June. On that auction date, the 30-year traditional Treasury was yielding 3.49% and it has since risen 25 basis points to 3.74%. The 30-year TIPS yield has actually declined a couple of basis points. That puts a pinch on the 30-year inflation breakeven rate, which currently stands at about 2.34%.

My theory is that a 30-year TIPS should pay at least 2% above inflation, which approximates the historical return for U.S. Treasurys. Looking back at historical data supports this, but there’s a big gap in the history because the Treasury halted 30-year TIPS auctions from 2002 to 2009, when TIPS yields were in a fairly stable pattern.

At this point, this auction will be very interesting to watch, maybe the most interesting of the year. If you are looking to give your TIPS ladder an interest-rate boost, and you can tolerate the ups and downs of a volatile 30-year issue, this will be one to consider.

The U.S. Treasury market has been surprisingly mundane during a month when the government partially shut down for lack of continued funding, and a potential default on U.S. debt and other obligations looms just seven days away.

The stock market is taking this crisis seriously, but the Treasury market seems to be saying: ‘Ho hum. We’re the safe haven. Bring it on.’ So, at a time when bonds are nearly  universally scorned as an investment, TIPS have outperformed stocks in the last one- and three-month periods, as these charts show:

All this indicates that the Treasury market still isn’t taking the threat of default seriously, but the stock market sees the shutdown as potentially harming the economy and cutting into corporate profits. Also, stocks had a mighty run leading into this crisis, while TIPS and Treasurys had been hammered by climbing interest rates.

There’s a 30-year TIPS auction coming up Thursday, Oct. 24, 2013. It will be a reissue of CUSIP 912810RA8, which carries a coupon rate of 0.625%. This one will be going off at a substantial discount, because this TIPS currently trades with a yield of about 1.378% and sells at a price of about $81.28 for $100 of value.

Some readers have told me they were expecting this yield to rise dramatically as the auction approaches in the middle of a crisis. However, that hasn’t been happening (and there could be some sort of temporary solution before the crisis actually arises). Here is the yield trend for a 30-year TIPS:

• Jan. 2, 2013: 0.47%
• Feb. 1, 2013: 0.58%
• Mar. 1, 2013: 0.52%
• Apr. 1, 2013: 0.58%
• Jun. 3, 2013: 0.95%
• Jul. 1, 2013: 1.28%
• Aug. 1, 2013: 1.40%
• Sep. 3, 2013: 1.54%
• Sep. 5, 2013: 1.64%
• Oct. 1, 2013: 1.39%

So after hitting a high of 1.64% on Sept. 5, the 30-year TIPS yields has been trending downward, about 25 basis points in all. This drop has coincided with the funding and default crisis in Washington.

If there actually were a default on U.S. debt, and bond holders did not receive interest payments and matured principal (highly unlikely, I’d say), then everything would change. First of all, short-term lending would freeze up, and there’s already some anxiety building about that prospect. From a Wall Street Journal story:

Yields on some Treasury debt are rising and the price to borrow cash against Treasurys is climbing as some lenders are unwilling to accept U.S. debt securities maturing in late October and early November as backing for their loans. …

The prospect of a U.S. default in coming weeks has prompted many banks, securities dealers and money-market funds to sell any U.S. debt that they believe bears default risk, including securities that would be used as collateral for repo loans.

BlackRock’s Matt Tucker, head of iShares fixed-income strategy, said in a CNBC interview this week that an actual default could lead to a sell-off in Treasurys. That didn’t happen in the 2011 debt crisis, when Treasurys soared as a haven investment. From the CNBC account:

“The difference here is that in 2011, we had a lot of concern about what was happening in Washington. This triggered a flight to safety, and Treasurys rallied,” Tucker said. But, he added, “if we actually saw a default, whether it was a technical or otherwise default by the Treasury, that could be a very different reaction. You actually could see a more mixed response from Treasurys, even a selloff.”

Today’s news seems to indicate some softening on both sides, which could lead to at least a short-term resolution of the debt-limit issue, if not the shutdown. The Wall Street Journal is reporting: “GOP to Unveil Temporary Increase to Debt Ceiling.”

The measure, which runs through Nov. 22, deals with just one of two major components of the spending standoff. It doesn’t reopen the government, which has been partially closed for 10 days, leaving that question to additional deliberations between lawmakers and the White House over government spending.

Interesting side note: The U.S. Treasury will formally announce the reopening of the 30-year TIPS on Thursday, Oct. 17, 2013, the very day the debt-ceiling crisis is supposed to go ‘live.’ How ironic. We’ll be watching.