Treasury Inflation-Protected Securities

• Headline inflation numbers matched the consensus forecast, but core inflation ran higher than expected. Gasoline prices were down, moderating overall inflation.
• With one month of data remaining, the Social Security COLA looks likely to increase 1.6% to 1.8% for January payments.
• The I Bond’s new variable rate, to be reset November 1, looks likely to be higher than the current rate of 1.4%.

There was an upside surprise in core inflation — which removes food and energy — with core inflation rising 0.3% in August and 2.4% over the last 12 months. The consensus estimate was for 0.2% for the month and 2.3% year-over-year.

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• The lowly EE Savings Bond now offers substantial yield advantages over similarly safe investments of the same term around the world.
• EE Bonds make sense only for investors who can hold them 20 years, creating an effective yield of 3.53%, compounded.
• They can be used as part of a 20-year plan toward a college education or retirement. Avoid them if you can’t be sure of holding them 20 years.

This doesn’t happen often, but in September 2019, a U.S. Savings Bond has become one of the very best bond investments in the world.

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• Today’s reopening auction generated a real yield of 0.501%, a whopping 59 basis points lower than the originating auction on February 21, 2019.
• Investors had to pay a huge premium for the 1.0% coupon rate, about $115.68 for about $101.79 of value, after accrued inflation is added in.
• Nevertheless, this auction appears to have been met with strong demand from big-money investors.

The real yield was down a bit from where this TIPS was trading on the secondary market at noon, an hour before the auction close. At that time, the real yield was 0.52%. The lower yield at auction indicates this issue had solid demand from investors.

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• The real yield looks likely to come in around 0.46%, down 63 basis points from the originating auction in February.
• Buyers will be paying a steep premium for the coupon rate of 1.0%, about 15% above par value.
• The inflation breakeven rate is currently running at a very low 1.57%, which should make this auction attractive for big-money investors.

Thursday’s reopening auction of CUSIP 912810SG4 – creating a 29-year, 6-months TIPS – is a particularly gruesome offering. The Treasury is selling $7 billion of this reopened TIPS, but no one outside of a central bank or pension fund should touch it.

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• The TIP ETF has had a total return of 8.33% so far in 2019, slightly outperforming the overall bond market.
• Shorter-term TIPS funds have also performed well, but the gain has been less dramatic.
• A relatively low 10-year inflation breakeven rate indicates that TIPS remain a solid choice versus nominal Treasurys. But TIPS funds are riskier today than they were a year ago.

Back on November 20, 2018 — yes, just nine months ago — I wrote an analysis of inflation-protected ETFs and asked, “Is It Time To Buy TIPS ETFs, Mutual Funds?” My conclusion was: Yes, the time is right, especially for shorter-term TIPS funds.

But I didn’t expect what would happen in the next nine months …

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• Both headline and core inflation numbers came in higher than expected, indicating inflation is not ‘dead’ and deflation is not looming.
• The July number sets a path for a 1.6% to 1.8% increase in the 2020 Social Security cost-of-living adjustment.
• At this point, with two months of data remaining, the I Bond’s variable rate will be higher than the current rate of 1.4%. It will be reset on November 1.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3% in July on a seasonally adjusted basis, the U.S.Bureau of Labor Statistics reported today. Over the last 12 months, “headline” inflation increased 1.8%.

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• The Social Security Administration uses a complex formula, and an unusual inflation index, to set the annual COLA increase.
• Once again, the Social Security COLA looks like it will be lower than overall U.S. inflation. (That wasn’t true for the 2019 increase, however.).
• At this point, a COLA increase in the range of 1.6% to 1.8% looks likely, but a lot can change in the only months that matter: July, August and September.

In its annual report issued in April, the Social Security Administration projected a likely 1.8% cost-of-living-adjustment (COLA) for Social Security recipients in 2020. That looks like a reasonable estimate, but possibly a bit high.

The COLA formula is ridiculously complex and little understood. Is it related to U.S. inflation? Yes, but not the inflation index you hear about each month. Does it reflect 12 months of U.S. inflation? Not really. Does it underestimate actual U.S. inflation? Most years, yes.

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