Treasury Inflation-Protected Securities

Apparently so. State Street Global Advisors, the world’s second largest asset manager, says in a regulatory filing that it is launching two new ETFs based on Treasury Inflation-Protected Securities:

• SPDR Barclays 0-5 Year TIPS ETF, which will track the Barclays 0-5 Year Government Inflation-linked Bond Index.
• SPDR Barclays 1-10 Year TIPS ETF, which will track the Barclays 1-10 Year Government Inflation-linked Bond Index.

The filing does not reveal the ticker symbols or the expected management fees associated with each ETF. Let’s see if State Street can approach the 0.10% expense ratio of the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP), which was launched in October 2012.

State Street currently provides an overall TIPS market ETF, the SPDR Barclays TIPS (IPE), with $740 million in assets and an annual expense ratio of 0.19%. But the giant here is the iShares Barclays TIPS Bond (TIP), with more than $21 billion in assets and an annual expense ratio of 0.20%.

Too many TIPS funds? Maybe not, but the surge in TIPS ETFs mirrors investors’ high interest in inflation protection, as the Fed pours cheap money into the economy, and the U.S. government fails to get deficits under control. ETFs often seem to be a lagging indicator — they rise up well after a sector goes hot.

Here’s a list from Yahoo Finance of currently available funds seeking inflation protection:

• FlexShares iBoxx 3-Year Target Duration TIPS Index Fund (TDTT)
• FlexShares iBoxx 5-Year Target Duration TIPS Index Fund Profile (TDTF)
• Global Advantage Inflation-Linked Bond Exchange-Traded Fund (ILB)
• iShares Global Inflation-Linked Bond Fund (GTIP)
• iShares International Inflation-Linked Bond Fund (ITIP)
• iShares Barclays Treasury Inflation Protected Securities Fund (TIP)
• iShares Barclays 0-5 Year TIPS Bond Fund (STIP)
• PIMCO Broad U.S. TIPS Index Exchange-Traded Fund (TIPZ)
• PIMCO 1-5 Year US TIPS Index Exchange-Traded Fund (STPZ)
• PIMCO 15 Year US TIPS Index Exchange-Traded Fund (LTPZ)
• Schwab U.S. TIPS ETF (SCHP)
• Vanguard Short-Term Infl-Prot Sec Idx ETF (VTIP)

I can understand the desire to go with shorter-term TIPS, because when rates begin rising the longer-term Treasurys are going to be slammed. A rise of just a half percentage point will drop the value of a 30-year TIPS by nearly 15%.

Short-term TIPS, though, lock in a return that will lag inflation by at least 1.6%. So it will take mighty high inflation to get any sort of return. On the other hand, your money market fund will lag inflation by the rate of inflation.

I don’t have a great answer for storing short-term cash. My personal preference is the Vanguard Short-Term Corporate Bond ETF (VCSH), with $5.4 billion in assets and an expense ratio of 0.12%. I can buy and sell this at Vanguard without any trading fees.

It currently yields 1.22%, versus a big question mark for a fund like Vanguard’s short-term VTIP. Vanguard, being super responsible as usual, lists VTIP’s current yield as  -2.13%, but that is before inflation, which is running about 1.7%. This means VTIP has a negative current yield. (On the other hand, VTIP’s net asset value has risen by about 1% more than VCSH’s since the launch in October, and that helps even out total return.)

This again points out the need to shop for the lowest possible expense ratios and trading fees when you invest in short-term bond ETFs.

The U.S. Treasury will announce Thursday – just a formality – that on March 21 it will auction a reopening of CUSIP 912828UH1, a 10-year Treasury Inflation-Protected Security that was first auctioned on Jan. 24. This creates a 9-year, 10-month TIPS.

This TIPS has a coupon rate of 0.125%, but will end up auctioning with a yield to maturity well below that, probably around -0.526%, where it was trading on the secondary market on Monday. This also means that buyers at the March 21 auction will have to ‘pay up’ to get that 0.125% coupon rate, probably around $106.10 for every $100 of value.

TIPS yields are gently rising, but earning 0.5% less than inflation for 10 years won’t be attractive to a lot of small investors. Buyers who hold to maturity won’t be looking for income, they will be seeking: 1) Capital preservation with a super-safe, conservative investment, and 2) protection against a burst of inflation in the next 10 years. These buyers can ignore the secondary market and just hang on to maturity.

TIPS traders, though, will want to be cautious. Not long ago, every single TIPS ever issued was trading above its original value, as yields to maturity dropped to record low after record low. That trend has now broken, as shown in this chart of recent 10-year TIPS auctions:

If the March 21 auction goes off with a yield of -0.52%, it will mark the third consecutive 10-year TIPS auction with a higher (although still negative) yield. Buyers of CUSIP 912828UH1 back in January have already seen its market value decline by about 1%.

The question is always: Where are interest rates headed, and when? Wish I knew the answer.

Breakeven rate. The 10-year Treasury closed Monday at 2.07%, its highest rate for the year. If the TIPS reissue goes off at -0.52%, it sets the 10-year breakeven rate at 2.59%, meaning that buyers are betting that inflation will average higher than 2.59% over the next 10 years. A breakeven rate above 2.5% is considered very high. Keep in mind that inflation in 2012 was only 1.7%.

I was away from my computer last week, and updating a blog with an iPad is pretty much hell on Earth. So, I’m catching up.

On Thursday, the same day as the 30-year TIPS auction, the U.S. announced that ‘headline’ inflation (CPI-U, the one that matters to holders of TIPS and I Bonds) was zero in January. Over the last 12 months ending in January, headline inflation has been running just 1.6%, giving recent buyers of TIPS a double whammy — yields negative to inflation combined with very low inflation.

As this chart shows, holders of TIPS have received zero in inflation adjustment to principal since October:

Excluding the volatile food and energy categories, core inflation rose 0.3 percent in January. Core prices have risen 1.9 percent in the past year, below the Fed’s inflation target of ‘less than’ 2.5%. This could indicate that the Fed will feel free to continue its aggressive buying of Treasurys. From the Associated Press report:

“As long as inflation readings remain relatively constrained and inflation expectations do not get out of control, the (Fed) has plenty of runway to continue its program,” Dan Greenhaus, chief global strategist at brokerage BTIG, said in a note to clients.

February CPI, however, is likely to tick upward because of sharply rising gas prices.

The U.S. Treasury announced today that it auctioned a new 30-year Treasury Inflation-Protected Security, with a coupon rate of 0.625%, and a yield to maturity of 0.639%.  This is CUSIP 912810RA8.

Buyers are getting a yield well above the record low for a 30-year TIPS, 0.479% for a reissue in October 2012. Today’s auction broke a string of five consecutive 30-year TIPS auctions (issues and reissues) that set records lows. I think that is significant.

Here’s the Treasury announcement.

Bill Gross

Are bonds, especially Treasurys, in a bubble, driven up by by a mob of wild-eyed coupon clippers, fighting to get 0.87% on a five-year traditional Treasury?

I ran across these comments from Bill Gross, co-founder of Pacific Investment Management who is also known as ‘The Bond King,’ while reading a week-old Barron’s. (I get behind, sorry). This is from the annual Barron’s Roundtable, part 3:

The Fed is buying 80% of the Treasury market today. It is remarkable to think that when the Treasury issues debt in the trillion-dollar-plus category, the Fed ends up buying most of it. The Treasury sells it to the banks and primary dealers, who sell it back to the Fed at a higher bid. This is a very different financial system from the free-market capitalism we’ve come to know. And it will continue until inflation exceeds the upper end of the central bank’s target of 2.5% or, by some miracle, we get real economic growth. …

With yields so minimal, an investor is obliged to ask whether investing is worth the risk, given the possibility that the central bank misjudges the situation. … The public doesn’t realize that when yields come down, prices go up, and when yields go up, prices go down. ….

Let me be clear. Bonds are artificially priced, but aside from long-term bonds, there don’t appear to be the elements necessary to pop the bubble. That’s because central banks are buying the majority of bonds, and the cash flow from the existing stock of bonds, when reinvested, as most is, is more than the supply of bonds.

My question is: If one buyer – a buyer than can magically create dollars – is buying 80% of U.S. Treasurys, can you call that a ‘bubble,’ or is it outright market manipulation? Are there great hordes of Americans buying Treasurys? Obviously not, if the Federal Reserve is buying up 80% of the new supply.

TIPS buyers, though, are bidding against both the Federal Reserve and a large contingent of investors who truly fear future inflation. And that is pushing TIPS up. Here is a 2-year chart of the TIP ETF versus Vanguard’s Total Bond Market ETF:

These two funds have similar durations, but the Total Bond Market has greatly lagged the returns of the TIP ETF over the last two years. By the way, the Federal Reserve began its market manipulation in mid 2011, and at that point the TIP ETF sharply changed course.

It is not a coincidence. It is market manipulation. Can that continue forever? No.

Are bonds overpriced? Yes. It there a bond bubble? My answer is no. Not at least in the total bond market.