This week’s 30-year TIPS reopening auction could set a record-low yield

Not much to like here. But will big-money investors jump aboard?

By David Enna,

First, let me get this off my chest: I’m not a fan of 30-year Treasury Inflation-Protected Securities. The long term is beyond my likely lifespan, and my investment style is to buy and hold TIPS to maturity.

A 30-year TIPS is a very volatile investment, and that can make it appealing to a gutsy bond trader. But even then, I think you’d need nerves of steel to jump aboard the Treasury’s reopening auction Thursday of a 30-year TIPS, CUSIP 912810SV1, even as we seem to be nearing an end to the Federal Reserve’s aggressive bond-buying stimulus.

Then again, with 30-year real yields at a record low, every single 30-year TIPS ever auctioned is now worth more than the original auction price. Traders, rejoice. Then … sell?

(I do hold two previous 30-year TIPS from long-ago auctions. CUSIP 912810FH6 with a coupon rate of 3.875%, maturing in April 2029, and CUSIP 912810QP6 with a coupon rate of 2.125%, maturing in February 2041. Those are my treasured little babies, and I’m not selling.)

What to expect

The Treasury is offering $8 billion of this 29-year, 6-months TIPS. It originated in an auction Feb. 18, 2021, with a real yield to maturity of -0.04%, just barely negative to future inflation. Its coupon rate was set at 0.125% and investors paid an adjusted price of about $105.01 for about $100.08 of value, after accrued interest and inflation were added in. That result ended up looking good for investors because the real yield came in at least 10 basis points higher than expected.

Now, six months later, you can track this TIPS on Bloomberg’s Current Yields page. It closed Friday with a real yield of -0.32% and a price of about $113.69. If that yield holds through Thursday’s auction, it would be the lowest ever for a TIPS auction of this term. The previous low of -0.272% was set a year ago, Aug. 20, 2020. Only two 29- to 30-year TIPS auctions have ever resulted in a negative real yield. Thursday’s auction will be the third.

The premium price is so high because of the spread between the coupon rate of 0.125% and the real yield of -0.32%. And it shows how the ultra-long maturity magnifies the risk (and possible gain) of a 30-year TIPS.

CUSIP 912810SV1 will carry an index ratio of 1.04326 on the settlement date of Aug. 31, meaning that investors will pay an adjusted price about 4.3% more than the purchase price, but receive a matching amount of additional principal. As a rough estimate, an investor seeking $10,000 of this TIPS could end up paying $11,700 for about $10,432 of value. Ouch.

Here is the trend in 30-year real yields over the last five years, showing the quick decline below zero as the Federal Reserve began aggressive bond-buying in March 2020. Although the real yield popped above zero from February to March 2021, it has again settled into a deeply negative range:

Inflation breakeven rate

With a 30-year nominal Treasury bond yielding 1.93%, this TIPS currently has an inflation breakeven rate of 2.25%, a bit high by historic trends but a reasonable number. Here is the trend in the 30-year inflation breakeven rate over the last five years:

The one remarkable thing about this chart is the massive surge higher after both Congress and the Federal Reserve launched aggressive economic stimulus programs in March 2020. Those measures have ignited inflation, as reflected by the current annual rate of 5.4%. The breakeven rate of 2.25% isn’t wildly out of normal. U.S. inflation over the last 30 years has averaged 2.3%, the lowest for any 30-year period beginning with 1971. So a breakeven rate of 2.25% looks entirely reasonable.

Final thoughts

I’m not going to be an investor in this TIPS. No secret there. Will big-money investors — the usual market for a 30-year TIPS — be enthusiastic buyers? I’m doubting that. A record-low real yield on a volatile long-term investment isn’t very appealing, especially as the Federal Reserve appears just months away from slowing down its bond buying. On the other hand, the inflation breakeven rate of 2.25% makes this TIPS a bit more appealing than a nominal 30-year Treasury.

I think we could see some surprises at this week’s auction. Could the real yield jump a bit higher, as it did in January’s weak auction? We’ll see. I’ll be on the road this week but will try to post the auction results as soon as possible after the 1 p.m. EDT close.

Meanwhile, here’s a history of recent 29- to 30-year TIPS auctions, showing how rare it is to have a 30-year TIPS with a negative real yield and a coupon rate of 0.125%:

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Investing in TIPS | 3 Comments

July inflation: What it means for TIPS, I Bonds and Social Security COLA

  • All-items inflation for July came in at 0.5% and 5.4% for the year.
  • The Social Security COLA is still on track for about a 6% increase.
  • I Bonds could get a variable rate of 6% (or higher) for six months.
  • TIPS principal balances continue rising at a brisk pace.

By David Enna,

The U.S. Bureau of Labor Statistics released its July inflation report this morning, and for the first time in awhile, economists’ inflation estimates were pretty much on target, after months of under-estimating the recent surge in U.S. inflation.

The facts. The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5% in July on a seasonally adjusted basis, the BLS said. Over the last 12 months, the all-items index increased 5.4%. While 0.5% indicated brisk inflation, the July number was well below the 0.9% inflation recorded in June. The July numbers came close to the consensus estimates, so they shouldn’t cause a market surprise this morning.

Core inflation, which removes food and energy, rose 0.3% in July, a bit below the consensus estimate of 0.4%. But year-over-year core inflation was 4.3%, matching the estimate. This was the smallest monthly increase in core inflation in four months. But, no surprises.

The report disclosed some disturbing trends in the prices of consumer “basics.” For example, the price of food increased 0.7% in July and is now up 3.4% year-over year. Gas prices surged 2.4% higher and are up 41.8% for the year. Shelter costs rose 0.4% in July, and are up 2.8% over the last year.

On the other hand, prices for used cars and trucks — a major trigger for higher inflation over recent months — rose only 0.2% for the month, after rising 10.5% in June. The index for new vehicles rose 1.7% and is up 6.4% for the year.

The index for motor vehicle insurance was one of the few major component indexes to decline in July, falling 2.8% after rising in each of the last 6 months. The index for airline fares fell slightly in July, declining 0.1% after rising sharply in recent months.

Here is the 12-month trend for both all-items and core inflation, showing the strong surge higher since February, as economic stimulus continued at a brisk pace while the U.S. economy was reopening:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates for I Bonds. For July, the BLS set the inflation index at 273.003, an increase of 0.48% for the month and 5.4% over the last 12 months. This was the seventh month in a row that non-seasonally adjust inflation ran higher than 0.40%.

For TIPS. The July inflation report means that principal balances for all TIPS will increase 0.48% in September, following increases of 0.90% in July and 0.93% in August. In September, principal balances will have increased 5.4% over the previous 12 months, a lofty number. Here are the new September Inflation Indexes for all TIPS.

For I Bonds. The July inflation report was the fourth in a six-month string that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on November 1. As of July, non-seasonally adjusted inflation in that four-month period ran at 3.07%, which would translate to an annualized variable rate of 6.14% for all I Bonds for six months. Obviously, that would make I Bonds an extremely attractive investment, but keep in mind that two months remain and inflation can be quite finicky in the summer months.

Here are the data so far:

You can find a lot more information on I Bonds on my “Inflation and I Bonds” page, where I track all the monthly inflation updates.

What this means for the Social Security COLA

The July inflation report is the first of three — for July to September — that will set the Social Security Administration’s cost of living adjustment for 2022. The SSA uses a three-month average of a different index, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), to set its COLA.

For July, the BLS set CPI-W at 267.789, an increase of 5.4% over the last 12 months. But remember, it will be the average of July to September inflation indexes — compared to the same three-month average a year ago — that will determine the Social Security COLA. In a recent article, I had predicted a COLA increase in the range of 5.8% to 6.2%.

At this point, the data are pointing to a 5.7% increase in the Social Security COLA, but that will rise if inflation continues to surge in the next two months. Here are the numbers so far, with the July inflation report setting the first of three data-points that will determine the COLA:

What this means for future interest rates

Because U.S. job growth seems to be surging and inflation is running much higher than the Federal Reserve’s target of “maybe 2.5%,” the Fed governors are pondering a tapering of their $120 billion in bond purchases a month. But I think an announcement of a future tapering date is still a few months away, and then we’ll see how the market reacts. In theory, medium and longer-term interest rates should rise, as they did in 2013.

Any increase in short-term interest rates is probably a year off, I’d guess.

The huge unknown factor is the effect of the delta variant of COVID-19 on the U.S. economy. If the current surge slows down, as it has in Europe, then it’s possible the economy will continue running very hot. That would force an earlier Fed action. But too much is unknown. Right now, with the 10-year Treasury yielding 1.34%, the market doesn’t seem to fear Fed tapering.

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in I Bond, Inflation, Investing in TIPS, Retirement, Social Security | 7 Comments

Any chance the Treasury will raise the I Bond’s fixed rate in November?

Let’s be realistic. It won’t happen.

By David Enna,

This is a question I’ve been getting often in reader e-mails: “Dave, do you think the Treasury will raise the I Bond’s fixed rate in November? Should I wait until November to buy?”

Here is my in-depth analysis:

  • Could the Treasury raise the I Bond’s fixed rate in November? Yes, it could.
  • Will the Treasury raise the I Bond’s fixed rate in November? No, it won’t.

The Treasury does not disclose how it sets the fixed rate on Series I Savings Bonds, and so this leads people to speculate about what’s coming at the next reset, on November 1. This is a very important decision, because the I Bond’s fixed rate stays with that investment until redemption or maturity in 30 years. The fixed rate is combined with an inflation-adjusted rate (I call it the “variable rate” but that’s not the official term) that adjusts every six months, based on official U.S. inflation.

Want to know more about I Bonds? Read this.

An I Bond purchased today will have a fixed rate of 0.0%, combined with a variable rate of 3.54%, creating a composite rate of 3.54% for six months. The fixed rate will be “reset” on November 1, but I’m predicting with 99% certainty that it will remain at 0.0%. Why not 100% certainty? Because the Treasury occasionally does strange things. But I don’t think that’s coming in November. Not under these market conditions.

I think the best indicator of a future I Bond’s fixed rate is the spread between the fixed rate and the real yield to maturity of a 10-year Treasury Inflation-Protected Security. Under “normal” circumstances, a 10-year TIPS will have a real yield 40 to 50 basis points higher than the I Bond’s fixed rate. This has varied widely, though, because the Treasury does strange things.

Take a look at this chart, which shows every fixed rate reset for the I Bond where the rate was higher than 0.0%, going back to November 2008.

The important thing to note is that in no case, going back 13 years, has the Treasury set the I Bond’s fixed rate above 0.0% when the 10-year TIPS had a negative real yield. Right now, a 10-year TIPS is yielding -1.19%, meaning that an I Bond with a 0.0% fixed rate has a massive 119-basis-point advantage over a 10-year TIPS.

Remember, under “normal” circumstances, a 10-year TIPS would have a 40- to 50-basis-point advantage over an I Bond. (This is justified because of the I Bond’s flexible maturity, tax-deferred interest and better deflation protection.) Now that situation is reversed, with the I Bond having a 119-basis-point advantage, making the I Bond a much, much better investment. There is no way, under these market conditions, that the Treasury would increase the I Bond’s fixed rate.

But things can change, right?

Hey, isn’t it possible that the Federal Reserve could radically change course and halt its bond-buying stimulus and begin raising interest rates, before November 1, causing 10-year real yields to soar well above zero? (I’ll pause here for laughter.) No, that isn’t going to happen.

I’d expect 10-year real yields to drift a bit before November 1, possibly even rise a bit, but not get anywhere near zero in just three months. So expect real yields to remain negative through 2021, and expect the I Bond’s fixed rate to remain at 0.0%.

Here’s a look back at the I Bond’s entire fixed-rate history back to 2008, which includes the Fed’s last periods of bond-buying-tapering (beginning in January 2014) and interest-rate-hiking (beginning in December 2015) and the effect these actions had on the 10-year real yield, and the I Bond’s fixed rate:

Note that the Fed’s initial launch into quantitative easing, in November 2010, set off a string of six consecutive I Bond rate resets to 0.0%. During that time, the 10-year real yield dipped well below zero several times at the reset date, and at each of those times the I Bond got a 0.0% fixed rate.

The fixed rate finally rose above 0.0% in November 2013, after a year of market turmoil caused by the bond market’s “taper tantrum.” Up to this point, the Fed had loudly announced its intention to taper, but didn’t actually begin slowing its bond buying until January 2014. It ended in October 2014.

Where are we right now?

At the moment, the Federal Reserve is holding short-term interest rates near zero and is buying $120 billion of Treasurys and mortgage-backed securities each month. We are solidly in a period of quantitative easing, but the Fed is now hinting it “may” begin scaling back its bond-buying “sometime in the future.”

What time in the past matches up our current conditions? I’d say mid-2012, when both the 5-year and 10-year TIPS had real yields deeply below zero. But by November 2013, when the Fed had announced plans to taper its bond buying — resulting in a bond market “taper tantrum” — the 10-year real yield had soared to 0.40% and the Treasury finally raised the I Bond’s fixed rate to 0.2%, up from 0.0%.

The past indicates we are a year or maybe 18 months away from a higher fixed rate for the I Bond, if the Fed carries through with its hints of an end to aggressive economic stimulus. But this Fed seems stubbornly insistent on keeping the stimulus pumping as long as possible. So who knows? But it won’t happen in 2021.

What this means for an I Bond purchase

If I am correct that the fixed rate will stay at 0.0%, I’d say it makes sense to buy I Bonds now to take advantage of six months of the very attractive composite rate of 3.54%. The next variable rate reset in November could be even higher, possibly has high as 6%, but all I Bonds will get that new variable rate for six months, no matter when they were purchased.

Waiting to purchase after November only makes sense if you think the fixed rate will rise. If it doesn’t, you’ll miss out on 3.54% for six months, an extremely attractive rate in our current market.

Looking back at Fed actions. Here is more on this topic, from a series of articles I wrote speculating on possible results of the Fed’s future actions:

When the Fed begins tapering, what will happen to TIPS?

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in I Bond, Savings Bond | Leave a comment

A 10-year TIPS matured in July. How did it do as an investment?

Not so well, it turns out, slammed by a decade of lower-than-expected inflation.

By David Enna,

Today we will take a look at CUSIP 912828QV5, a 10-year Treasury Inflation-Protected Security that originated on July 15, 2011, with a real yield to maturity of 0.639%. It matured on July 15, 2021. The question: How did it do as an investment, versus a nominal 10-year Treasury note?

I’ve been tracking the performance of every maturing 5- and 10-year TIPS on my Tips vs. Nominals page, and for much of the last decade-plus, TIPS have been a fairly lousy investment, at least versus a nominal Treasury of the same term. The reason: Inflation expectations at the time of issue ended up being higher than actual inflation over the term of the TIPS. When inflation lags expectations, TIPS perform poorly.

Back on July 11, 2011, CUSIP 912828QV5 auctioned with a real yield of 0.639% and a coupon rate of 0.625%, terms that look super appealing today. Yet it’s hard to believe that 0.639% was the second lowest 10-year TIPS auction result in history, up to that point. In July 2011, we were just entering a decade-plus era of Federal Reserve intervention in the bond markets. Just six months later, in January 2012, a new 10-year TIPS auctioned with a real yield of -0.046%, the first of nine straight auctions of this term with a negative real yield.

The key factor in judging the performance of a TIPS versus a nominal Treasury is the inflation breakeven rate, the spread between the real yield of a TIPS and the nominal yield of a Treasury. That spread represents a prediction from investors about future inflation. Unfortunately, this prediction is almost always wrong, too high or too low. And for the last decade, investors have been betting on higher inflation than actually resulted.

Here are the data for maturing 10-year TIPS:

Although CUSIP 912828QV5 had an appealing real yield of 0.639%, on the day of the auction the 10-year Treasury note was yielding 3.03%, creating an inflation breakeven rate of 2.39%, rather high for that period. Ten years later, inflation had averaged just 1.8%, meaning that the TIPS under-performed the nominal Treasury by 0.59% a year.

Investors in this TIPS ended up missing out on a strong month for inflation, because inflation accruals for a TIPS are set by inflation two months prior to the accrual. So, this TIPS did not get a bump from a 0.93% increase in non-seasonally-adjusted inflation in June 2021. If June had counted, the annual inflation rate would have risen to 1.9% and the variance would have dropped to -0.49%.

Some thoughts and qualifications

We just completed a decade-long period of inflation running at less than 2.0%. In general TIPS out-perform nominal Treasurys when the inflation-breakeven rate drops below 2.0%, especially for 10-year TIPS. But the next decade could be entirely different. Never predict the future decade based on the performance of the past decade.

Also, this chart is an estimate of performance, because it uses a full month of inflation in the ending month, when actually TIPS accruals are based on a half month for the first and last months, with the origination and maturity occurring on the 15th of the month.

Keep in mind that interest on a nominal Treasury and the TIPS coupon rate is paid out as current-year income and not reinvested. So in the case of a nominal Treasury, the interest earned could be reinvested elsewhere, which would potentially boost the gain. For certain, we don’t know what the investor could have earned precisely on an investment after re-investments.

In the case of a TIPS, the inflation adjustment compounds over time, and that will give TIPS a slight boost in return that isn’t reflected in the “average inflation” numbers presented in the chart.

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Inflation, Investing in TIPS | 5 Comments

Auction of new 10-year TIPS gets record-low real yield of -1.016%

By David Enna,

The U.S. Treasury’s auction today of $16 billion in a new 10-year Treasury Inflation-Protected Security resulted in a real yield to maturity of -1.016%, the lowest in history for any TIPS auction with a 9- to 10-year term.

This is CUSIP 91282CCM1, and it was assigned a coupon rate of 0.125%, the lowest the Treasury will go for any TIPS.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or in this case, below) inflation.

In the case of CUSIP 91282CCM1, investors were willing to accept a real yield that will lag official U.S. inflation by 1.016% a year for 10 years. Why would they do that? Two reasons: 1) because a TIPS offers protection against unexpectedly high future inflation, and 2) the yield of a nominal 10-year Treasury — currently at 1.25% — is also highly likely to lag inflation, but with no upside potential. For many investors, a TIPS looks like the better option.

Investors at Thursday’s auction had to pay a steep premium price to collect that coupon rate of 0.125%, plus future inflation accruals. The adjusted price for this TIPS was about $112.42 for about $100.44 of value, after accrued inflation and interest are added in. This TIPS will have an inflation index of 1.00387 on the settlement date of July 30.

The auction appears to have gone off without a hitch. The real yield was a bit lower than the Treasury’s yield estimate of -0.98% at the market close Wednesday. But at 12:30 p.m., the most recent 10-year TIPS trading on the secondary market was yielding -1.03%. So -1.016% looks like a reasonable result. The auction’s bid-to-cover ratio was 2.5, a solid if not stellar number.

Here is the year-to-date trend in 10-year real yields, showing the recent dip in yields as the delta variant of COVID-19 raises fears of a future economic slowdown:

This recent dip, however, is remarkable because it has followed the Federal Reserve’s June 16 “talking about talking about” meeting that should be setting a course toward tapering of its aggressive bond-buying program. When that bond buying ends — if it ever ends — both nominal and real yields are almost certain to rise.

Inflation breakeven rate

The one oddity of this auction is a dip the 10-year inflation breakeven rate for this TIPS, which came in at 2.27%, a bit below recent auctions of this term. The breakeven rate is determined by subtracting the real yield of this TIPS (-1.016%) from the current nominal yield of a 10-year Treasury (1.25%). The result is 2.27%. It means that this TIPS will outperform its nominal counterpart if inflation averages more than 2.27% over the next 10 years.

While 2.27% is high by historical standards, it seems reasonable given recent trends, with official U.S. inflation running at an annual rate of 5.4% as of June. So it is interesting to see that inflation expectations are now beginning to ease.

Here is the trend in the 10-year inflation breakeven rate for 2021 year to date:

Reaction to the auction

The TIPS ETF — which holds the full range of TIPS maturities — had been trading slightly higher all morning, indicating slightly lower yields. After the auction’s close at 1 p.m., the ETF ticked up, slightly. Not much to see here. This auction went off as expected.

Investors at today’s auction probably had to hold their noses to accept a record-low real yield for auctions of this term. However, the slight decline in the inflation breakeven rate reinforces the advantage of a TIPS over a nominal Treasury of the same term. Who wants to accept 1.25% for 10 years?

This TIPS will be reopened at auctions in September and November. It will be interesting to watch the trend in real yields through the end of the year.

Here’s a history of recent auctions of the 9- to 10-year term, dating back to January 2020. Note that today’s auction was the 8th in a row to get a negative real yield:

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Investing in TIPS | 2 Comments