Treasury Inflation-Protected Securities

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.

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.

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.

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?

Keep watching.