Treasury Inflation-Protected Securities

• The Treasury will reopen CUSIP 912810SM1 in a Thursday auction, creating a 29-year, 6-month TIPS.
• The real yield looks likely to be around -0.26%, making this the first TIPS of this term to get a negative real yield.
• Investors will probably pay a huge premium, about 16% above par value. This TIPS isn’t attractive for a buy-and-hold-to-maturity investor.
• But for a TIPS trader, it might have speculative appeal.

• In a surprise, July inflation came in much higher than the consensus for both all-items and core inflation. Gas prices again were a big factor.
• The recent surge in inflation now has the Social Security COLA on track for a 1.0% increase in 2021. But two volatile months of data remain.
• I Bond investors now look likely to get a positive inflation-adjusted variable rate at the November 1 reset.

U.S. inflation in July blew by consensus forecasts, reflecting strong price increases in many categories across the economy, even though food prices declined in the month.

The Consumer Price Index for All Urban Consumers increased 0.6% in July on a seasonally adjusted basis, the same increase as in June, the U.S. Bureau of Labor Statistics reported today. That was double the expected increase of 0.3%.

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• The overall TIPS market has had a huge run-up of almost 16% since the bond market turmoil of mid-March.
• The TIP ETF hit a record high of $126.51 last week, but its one-year performance has been in line with other big bond funds.
• This ETF is not diversified, with only 42 holdings of a single type of U.S. Treasury. It is more volatile than core bond funds.

The iShares TIPS Bond ETF (TIP), which holds the full range of Treasury Inflation-Protected Securities, has had a huge run-up in the last five months, rising almost 16% since it closed at $108.81 on March 18, a day of intense market turmoil. On Thursday, August 6, it closed at a record high of $126.51.

Many readers have been asking me: After this year’s big run-up, is it too late now to begin investing in TIPS?

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• There have been 104 auctions of this 9- to 10-year term since 1997 and today’s result was a record low yield, by a large margin.
• The inflation breakeven rate came in at 1.52%, a reasonable number but higher than recent trends. Inflation expectations are slowly rising.
• Reaction to the auction looked mixed, with TIPS yields rising slightly after the auction’s close at 1 p.m. EDT.

The U.S. Treasury just completed its auction of $14 billion in a new 10-year Treasury Inflation-Protected Security, with a historic result: A real yield to maturity of -0.93%, the lowest in the 23-year history of TIPS auctions of this term.

This is CUSIP 912828ZZ6, and it got a coupon rate of 0.125%, the lowest the Treasury will allow for a TIPS. That means investors at today’s auction had to pay a huge premium for this TIPS: an adjusted price of about $111.03 for about $100.01 of value, after accrued inflation and interest are added in.

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• The real yield for CUSIP 912828ZZ6 could end up around -0.82%, the lowest in the 23-year history of TIPS auctions of this term.
• Fears of future inflation – spurred by massive monetary and fiscal stimulus programs – should attract investors.
• The inflation breakeven rate will be around 1.46%, a reasonable number. But if the inflation hawks are right that 1.46% number will look very attractive.

Here’s the question: Would you prefer a 10-year TIPS yielding 0.82% less than inflation or a 10-year Treasury note with a nominal yield of 0.64%? And how will these investments perform under a scenario of possible rising inflation?

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• Both all-items inflation and core inflation rose faster in June than the consensus estimates.
• Will any of this alter the Federal Reserve’s commitment to ultra-low interest rates? No.
• The June inflation report offers a glimmer of hope for a small increase in the Social Security COLA in 2021.

• The Social Security Administration uses an esoteric inflation index and only three months of data to determine the COLA.
• As of the May inflation report, the COLA would be set to zero. But May’s number is pretty much irrelevant to the final calculation.
• Should we expect inflation or deflation in coming months? Most experts expect deep deflation, but could mild inflation sneak into the picture?

You might think the Social Security Administration’s annual cost-of-living adjustment for Social Security benefits is based some sort of index that accurately reflects “official U.S. inflation.” That would be wrong.

You might also think the SSA’s COLA is based on some sort of 12-month year-over-year calculation of annual inflation. That would be wrong, too.

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