Treasury Inflation-Protected Securities

Last pitch for buying I Bonds in 2011

Posted on December 4, 2011 by Tipswatch

The Treasury will auction a 5-year TIPS on Dec. 15, probably a reissue of CUSIP 912828QD5 that currently carries a yield-to-maturity of -0.980%. Yes, that is a negative, and it means buyers of this TIPS are willing to accept a rate of return nearly 1% lower than the rate of inflation for the next five years.

Why would they do that?

1) This TIPS is a super-safe investment, 2) world markets are still in turmoil and super-safe investments look attractive, 3) the Federal Reserve won’t budge on raising interest rates anytime soon, and 4) there aren’t many super-safe alternatives.

A 5-year nominal Treasury is paying 0.92%. That means the TIPS buyer needs inflation to run at 1.9% or more over the next 5 years to win over a nominal Treasury. Not a bad bet, plus the buyer gets protection from higher inflation.
The best 5-year CD is paying 1.84% (Ally Bank, as of Friday). That one actually competes pretty well with the 5-year TIPS, pushing the break-even inflation rate up to 2.82%. Before you buy that 5-year TIPS, look hard at this CD. But you would give up protection against higher-than-expected inflation.
On the other hand, the average 5-year bank CD is paying 1.17%, not very attractive versus the TIPS.

I Bonds, still the better investment. If you didn’t buy I Bonds before the Oct. 31 interest-rate change, go ahead, kick yourself. The six-month rate fell from 4.6% to 3.06% for the six months ending in April 2012. (Buyers get the current rate for six months after the purchase, so you could have guaranteed yourself a 2.3% 1-year return, or better.)

Forget that 4.6% rate. If you haven’t bought I Bonds in 2011, you should still ponder this investment before Dec. 31. Here’s why: The Treasury puts yearly limits on I Bond purchases. You can buy $5,000 in Treasury Direct and $5,000 in paper bonds each year. A couple can buy twice that. Paper bonds will no longer be issued after Dec. 31, except as a tax refund.

So you could still load up on this I Bond in 2011 (paper and electronic) and then again in 2012 (just Treasury Direct purchases and your tax refund).

I Bonds currently carry a base interest rate of 0%, plus an inflation-matching interest rate that changes every six months. That makes them much more attractive than a 5-year TIPs with a return that is is 0.98% below the inflation rate. Zero is good. Negative 0.98 is bad.

The current I Bond interest rate – 3.06% – guarantees that you will receive a 1-year return of 1.53%, but probably higher, even if you sell after one year and pay a three-month interest rate penalty. If you sell after 5 years, there is no penalty.

While you could consider a 5-year CD if you can find an attractive rate, there really is no contest between this I Bond purchase and the 5-year TIPS reissue of Dec. 15. I Bonds are still the clear winner, even at a lower interest rate.

And if you have purchased I Bonds up to the limit in 2011, you can hold that investment for one month and buy them again in January 2012.

Posted in I Bond, Investing in TIPS, Savings Bond | 3 Comments

Thursday’s TIPS auction … a little strange

Posted on November 20, 2011 by Tipswatch

The Treasury on Thursday auctioned a reissue of a 10-year TIPS and it went off at a higher-than-expected yield of 0.099%, in addition to the inflation adjustment. This was nice news for the new buyers of this TIPS, since it had recently been trading in the secondary market with a negative real yield. On Wednesday, experts had predicted a yield of 0.06%.

So the TIPS auction generated a higher yield, while at the same time, yields on nominal Treasuries were declining. This chart paints the picture:

It’s remarkable that intermediate Treasuries were peaking around noon Thursday, the time of this week’s auction, and at that same time the TIP ETF was hitting its low, down about 1% for the week.

Like I said, this is good news for the buyers at Thursday’s auction. The yield of 0.099%, while paltry by historical standards, seemed pretty generous in today’s market.

Consider this: On Thursday, the rate on a nominal 10-year Treasury dipped to 1.96%, the lowest yield for any day this month. And that shows why a 10-year TIPS, paying a near-zero real return, is so much more attractive than a 10-year Treasury.

10-year Treasury: Worst it can do = 1.96%. Best it can do = 1.96%.

10-year TIPS: Worst it can do = 0%, assuming 10 years of deflation. Best it can do = unlimited, matching the inflation rate plus 0.099%

The TIPS buyer does better over 10 years if inflation averages more than 1.861%. I can’t predict the future, but I suspect inflation will be higher than 1.861% over the next 10 years, possibly much higher.

From a Bloomberg report on the auction:

“It wasn’t a great auction,” said Michael Pond, co-head of interest-rate strategy in New York at primary dealer Barclays Plc. “There has been a flight to liquidity into nominal Treasuries, and when that happens these auctions can go much worse.”

It’s good to be reminded that TIPS and Treasuries don’t always track together. When nominal Treasury yields decline because of fears of deflation, TIPS can take a hit.

Posted in Investing in TIPS | Leave a comment

10-year TIPS reissue auctions at 0.099%

Posted on November 17, 2011 by Tipswatch

The U.S. Treasury just posted the result of today’s auction of CUSIP 912828QV5, a 9-year, 8-month TIPS that auctioned at a yield to matury of 0.099%, close to but not quite the lowest rate in the history of 9- or 10-year TIPS auctions.

This TIPS has a coupon rate of 0.625%, so buyers paid a premium ($105.73 for each $100 of this issue).

The positive rate is a plus for TIPS buyers. Until very recently this TIPS was trading with a negative yield to maturity. The all-time low for a 9- or 10-year TIPS was for this same TIPS, 0.078% when it was reissued on Sept. 30.

Posted in Investing in TIPS | 1 Comment

Consumer Price Index falls 0.1% in October

Posted on November 16, 2011 by Tipswatch

Investors in Treasury Inflation-Protected Securities and I Bonds have been enjoying decent returns for the last year, thanks to higher-than-expected inflation.

But that trend turned in October, with the Consumer Price Index falling 0.1% because of lower prices on gas, cars and computers. The index for all items less food and energy (the ‘core inflation rate’) rose 0.1% in October, the same increase as in September.

This October number isn’t great news for holders of TIPS, who will see their principal balances fall slightly. But over the last 12 months, CPI has increased 3.5%, still providing a return that make TIPS attractive over nominal Treasuries.

It’s also interesting that the stock market is shaky today because the price of oil is rising above $100 a barrel. If this continues. it’s likely that the recent fall in gas prices would be reversed.

Update on Nov. 17 reissue of 10-year TIPS

The market rate of the Jul 2021 TIPS that will be reissued Thursday has risen into positive territory, and the overall TIPS market has weakened slightly today. That may mean the reissue will carry a positive yield (in addition to inflation adjustment to principal).

No 9- to 10-year TIPS has ever auctioned with a negative yield, and that trend might continue. We will learn the result at 1 p.m. Thursday.

Here’s my post from last week with more information on CUSIP 912828QV5.

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Next TIPS auction: 10-year reissue auctioning Nov. 17, 2011

Posted on November 9, 2011 by Tipswatch

The U.S. Treasury has announced that the 10-year TIPS auction set for Nov. 17 will be a reissue of CUSIP 912828QV5, which originally auctioned on July 21 with a coupon rate of 0.625% and a yield to maturity, before the inflation adjustment, of 0.639%.

Back in July, I was wary of the new issue because it looked like it would auction below 0.5%. Boy, I was wrong about that! It ended up that this 10-year was quite attractive. The yield at auction ended up higher than predicted, and since then, TIPS yields have been plummeting.

Here’s the current picture for CUSIP 912828QV5:

The yield to maturity is slightly negative, at -0.08%, meaning that investors today are willing to accept -0.08% less than the rate of inflation over the next 10 years.

Buyers of the Nov. 17 reissue are going to have to pay about a 6% premium to get this issue’s 0.625% coupon rate. That means a $1,000 investment is going to cost you $1,060, resulting in a yield of about -0.08%.

(That rate might not hold, however. The European debt crisis and turmoil today in the world stock markets will assure higher Treasury prices today. You can check daily TIPS prices here.)

The case for CUSIP 912828QV5. If you are buy-and-hold TIPS investor, and need to place money in a super-safe investment, this issue might still be attractive. You have few alternatives:

The standard 10-year Treasury today is paying 2.1% (and that could dip again this week). If you think inflation will run higher than 2.18% over the next 10 years, this TIPS is a more attractive investment.
The best 5-year CD you can find today is paying 1.89%.
The standard 5-year Treasury is paying 0.92%

I think 10-year issues are the ‘sweet spot’ TIPS investment, giving you some advantage in yield over shorter-term issues, plus they are excellent for use in a TIPS ladder, with your TIPS maturing every year in the future. (Nowadays, the 30-year TIPS is the sweet spot for yield, but lousy for a ladder for the buy-and-holders.)

If you are TIPS ‘trader,’ I can’t see buying this TIPS for quick capital gain. You should have bought it back in July.

The case against CUSIP 912828QV5. As an old-time TIPSter, I know that the ‘normal’ yield for a 10-year TIPS is in the 1.5% to 2.5% range, and I do believe we will return there if the U.S. economy gets back into growth mode. (When? In my lifetime?)

This same TIPS was reissued a month ago with a yield of 0.078%, which broke through the record low by a wide margin. One month later, the yield has fallen another 16 basis points, and could go lower by next week.

Here’s a look at every 9-to 10-year TIPS ever issued (the yield column is where you need to focus to appreciate the historical trend):

There has never been a 10-year TIPS issue or reissue with a negative yield. Will the Nov. 17 reissue finally break through this barrier?