Treasury Inflation-Protected Securities

Weak demand results in real yield of 2.121% for 5-year TIPS reopening auction

Posted on December 19, 2024 by Tipswatch

By David Enna, Tipswatch.com

The U.S. stock and bond markets were sent into turmoil Wednesday by confusing messaging from the Federal Reserve on future inflation and interest rates. As a result, the stock market plummeted and Treasury yields surged higher.

While that turmoil has lessened today, it had a strong effect on the Treasury’s auction of $22 billion in a reopened 5-year Treasury Inflation-Protected Security, CUSIP 91282CLV1. Before the Fed action on Thursday, this TIPS was trading on the secondary market with a real yield to maturity of about 1.85%. In the aftermath Wednesday afternoon, the yield surged to about 2.02%.

And then … today’s auction resulted in a real yield of 2.121%, about 7 basis points higher than the “when-issued” prediction of 2.05% set just before the auction’s close. The bid-to-cover ratio was 2.1, by far the lowest for any 4- or 5-year auction since I began tracking this number in 2019. (The lowest previously was 2.36 in October 2023.)

In other words, demand for this TIPS was extremely weak. But for investors, the result was excellent: a real yield to maturity of 2.121% and a price below par value.

Definition: The “real yield” of a TIPS is its yield above or below official future U.S. inflation, over the term of the TIPS. So a real yield of 2.121% means an investment in this TIPS would provide a return that exceeds U.S. inflation by 2.121% for 4 years, 10 months.

Here is the trend in the 5-year real yield over the last four years, ending on Tuesday, a day before the surge higher:

Pricing

CUSIP 91282CLV1’s coupon rate of 1.625% was set by the originating auction on Oct. 24, which resulted in a real yield of just 1.670%, a remarkable 45 basis points lower than today’s result. Today’s auction got an unadjusted price of 97.750475. It also will carry an inflation index of 1.00317 on the settlement date of Dec. 31. With that information, we can calculate the cost of $10,000 par value at this auction:

Par value: $10,000.
Actual principal purchased: $10,000 x 1.00317 = $10,031.70
Cost of investment: $10,031.70 x 0.97750475 = $9,806.04
+ Accrued interest of $34.48.

In summary, at investment of $10,000 par at this auction cost $9,806.04 for $10,031.70 principal on the settlement date of Dec. 31. After that, the investor will receive inflation accruals plus an annual coupon rate of 1.625% until maturity.

Inflation breakeven rate

With a 5-year nominal Treasury note yielding 4.44% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.32%, a bit lower than looked likely last week. This means it will outperform the 5-year T-note if inflation averages more than 2.32% over the next 4 years, 10 months.

Here is the trend in the 5-year inflation breakeven rate over the last four years:

Reaction to the auction

The fact that demand was so weak is a stunner. It could be that investors were reacting to the Fed’s apparently renewed commitment to fighting inflation. The dip in the inflation breakeven rate backs that up. It could also be that nominal Treasurys are looking more attractive by comparison with yields in the 4.40% range.

This is from MarketWatch’s coverage posted after the auction close:

Thursday afternoon’s $22 billion sale of 5-year Treasury inflation-protected securities came in “very weak” with a tail of 6.7 basis points, according to BMO Capital Markets strategist Vail Hartman.

And here is a bit more blunt reaction from Bloomberg’s Cameron Crise, picked up from a tweet:

Buyers at this auction should be pleased. This is one where the auction ended up producing a better result than buying on the secondary market. The weak demand seems obviously related to uncertainty about future inflation and a potential hold in short-term interest rates.

And then, on top of all that, Congress is now struggling to avoid a government shutdown. Fun times, huh?

This was the last TIPS auction of 2024. The next auction will Jan. 23, 2025, with the unveiling of a new 10-year TIPS to mature in 2035. I plan to be a buyer of that one.

• Now is an ideal time to build a TIPS ladder

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• TIPS investor: Don’t over-think the threat of deflation

• Upcoming schedule of TIPS auctions

* * *

Follow Tipswatch on X (Twitter) for updates on daily Treasury auctions and real yield trends (when I am not traveling).

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear. Please stay on topic and avoid political tirades. NOTE: Comment threads can only be three responses deep. If you see that you cannot respond, create a new comment and reference the topic.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Federal Reserve, Inflation, Investing in TIPS | Tagged bonds, inflation, investing, personal-finance | 18 Comments

Rise in real yields (once again) makes 5-year TIPS auction look attractive

Posted on December 15, 2024 by Tipswatch

By David Enna, Tipswatch.com

Update, Thursday 1:35 p.m. ET: Weak demand results in real yield of 2.121% for 5-year TIPS reopening auction

Update, Wednesday 5:17 pm ET: The Federal Reserve’s mixed messaging on inflation (expected to be a bit higher next year) and interest rates (going ahead with some cuts, but fewer) caused a strong market reaction, sending both real and nominal yields higher. This TIPS, CUSIP 91282CLV1, closed Wednesday with a real yield of 2.03%.

This could be a temporary move and could revert lower in the morning. No way to know.

——————-

Just a week ago, I posted an article theorizing that real yields for Treasury Inflation-Protected Securities were beginning to crest, especially for shorter-term issues.

Note to readers: Sometimes I am wrong, especially when trying to pinpoint trends in real yields. In the last week, spurred by a too-high U.S. inflation report and fears of future rate “holds” from the Federal Reserve, both nominal and real yields have jumped higher.

This was even more true for nominal Treasurys. The yield on a 10-year Treasury note jumped from 4.19% on December 4 to 4.40% at the close Friday, an increase of 21 basis points.

All of this is leading up to Thursday’s reopening auction of CUSIP 91282CLV1, creating a 4-year, 10-month TIPS. Its coupon rate was set at 1.625% by the originating auction on October 24 and it closed Friday on the secondary market with a real yield of 1.83% and a price of 99.04.

Definition: The “real yield” of a TIPS is its yield above or below official future U.S. inflation, over the term of the TIPS. So a real yield of 1.83% means an investment in this TIPS would provide a return that exceeds U.S. inflation by 1.83% for 4 years, 10 months.

One semi-interesting fact about this auction: The Treasury set the size at $22 billion, which is the largest in history for a 5-year reopening. Last December, the auction size was $20 billion. Could these growing auction sizes eventually hold down demand? (Probably not, at this point.)

Here is the trend in the 5-year real yield over the last 14 years, showing that while yields have fallen off highs of October 2023, they remain attractive by the standards of the last decade-plus:

Pricing

If real yields hold at these higher levels, this TIPS reopening should get a price discount of about 1% to accrued principal. It will carry an inflation index of 1.00317 on the settlement date of December 31. All of this means it should end up auctioning at a price very close to, or below, par value.

Here is a look at a potential $10,000 par-value investment, based on Friday’s market close:

Par value: $10,000
Actual principal purchased: $10,000 x 1.00317 = $10,031.70
Cost of investment: $10,031.70 x 0.9904 = $9,935.40
+ Accrued interest: About $34.45

In this scenario, which will change before the auction’s close, an investor would pay $9,935.40 for $10,031.70 of principal and then get inflation accruals for 4 years, 10 months, plus annual coupon payments of 1.625%, distributed in April and October. The cost of the accrued interest will be returned at the first semi-annual coupon payment on April 15.

There is no particular reason for an investor to wait for the Thursday auction to purchase CUSIP 91282CLV1. It could be purchased any time on the secondary market. The auction result could end up better, or worse, but the yield will be uncertain until the auction close. On the secondary market, you can buy when you find the yield attractive.

Inflation breakeven rate

With the 5-year nominal Treasury note closing Friday at 4.25% (pretty attractive, in my opinion) this TIPS currently has a rather-high inflation breakeven rate of 2.42%. However, annual inflation over the last 5 years has averaged 4.2% and over 10 years, 2.9%. So 2.42% doesn’t look unreasonable, and reflects market fears that U.S. inflation is proving to be “sticky” in this range of 2.5% or higher.

Here is the trend in the 5-year inflation breakeven rate over the last 14 years, showing that inflation expectations have fallen off in the last two years, but remain relatively high by historical standards:

I’ll remind you that the inflation breakeven rate is not a predictor of future inflation. It simply measures market sentiment by comparing nominal and real yields. However, if inflation did remain at 2.42% or higher over the next five years, I think we could expect a continued diet of relatively high Treasury yields. The Fed should not be easing if inflation remains elevated.

Thoughts

I won’t be a buyer this week because the 2029 rung of my TIPS ladder is fully loaded. But I think CUSIP 91282CLV1 looks like an attractive purchase if its real yield holds around 1.80%.

I hear from a lot of readers holding out to purchase TIPS with real yields higher than 2.0%, a number I often call “historically attractive.” Patience may pay off … or it won’t. Real yields are notoriously finicky. A real yield of 1.83% on a 5-year TIPS is attractive, and the maturity date is only 4 years, 10 months away.

On the other hand, if you want to balance off TIPS and I Bonds with some shorter-term nominal investments, a nominal yield of 4.25% on a 5-year Treasury note also looks attractive. I tend to prefer TIPS for terms of two years or longer, however, for the inflation protection over the longer term.

This TIPS auction closes Thursday at 1 p.m. EST. Non-competitive bids at TreasuryDirect must be placed by noon Thursday. If you are putting an order in through a brokerage, make sure to place your order Wednesday or very early Thursday, because brokers cut off auction orders before the noon deadline.

I will be posting the auction results soon after the close on Thursday. Here is a history of auction results for this term over the last 5 years:

• Now is an ideal time to build a TIPS ladder

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• TIPS investor: Don’t over-think the threat of deflation

• Upcoming schedule of TIPS auctions

* * *

Follow Tipswatch on X (Twitter) for updates on daily Treasury auctions and real yield trends (when I am not traveling).

Posted in Bank CDs, Inflation, Investing in TIPS, TreasuryDirect | Tagged bonds, inflation, investing, personal-finance, Treasury investments | 28 Comments

Treasury is ending its Payroll Savings Plan for purchasing savings bonds

Posted on December 13, 2024 by Tipswatch

By David Enna, Tipswatch.com

I was alerted by a reader yesterday about an email sent from TreasuryDirect informing him that it is “discontinuing the ability” to fund savings bond purchases through payroll deductions.

Of course, the Treasury didn’t make this easy to understand. Technically, it said Treasury is ending payroll contributions to its zero-interest Certificate of Indebtedness (C of I) account, which is then used to buy savings bonds at regular intervals.

The email said:

As of January 31, 2025, TreasuryDirect customers will no longer be able to fund C of I from their paycheck. Contact your payroll provider to stop electronic deposits before January 31, 2025. After this date, any deposits to your C of I will be rejected.

The email links to TreasuryDirect user guide sections 301 to 310, which give “clarification” for this change. These instructions, naturally, are quite dense and mysterious, as is common with communications from TreasuryDirect. From User Guide 307:

The Payroll Zero-Percent Certificate of Indebtedness (Payroll C of I) is a Treasury security that does not earn any interest. It was previously intended to be used as a source of funds for purchasing Series EE and Series I Savings Bonds through the Payroll Savings Plan in TreasuryDirect, which will be discontinued on January 31, 2025.

The Payroll Savings Plan will be discontinued on January 31, 2025. You must contact your employer (payroll office) to have your payroll allotment/direct deposit stopped.

Rewriting history

The history of the payroll deduction program dates back at least to 1942, when the Treasury approved use of payroll deductions for the purchase of War Bonds. This later became known as the Payroll Savings Plan.

TreasuryDirect has a page providing a history of its Payroll Savings plan, noting that “In the minds of millions of Americans who grew up from the 1940’s through the 1990’s, savings bonds and payroll savings are synonymous. Many have never bought a bond in any other way.” But …

Payroll savings began a long decline in the 1980’s, as markets changed, and new financial products were created and began to be offered by employers. Products including 401(k) plans and employee stock option plans, both designed to help employees save for their futures as defined benefit retirement plans, gradually became the rule rather than the exception among large employers. These plans were more attractive to many employees, despite being less liquid.

In early 2003, Congress ended funding for the marketing of savings bonds, accelerating a previously slow decline for the payroll savings plan.

And then … “The payroll savings plan will be discontinued on January 31, 2025.”

And that means?

I suspect this is part of changes we will see in the savings bond program in the early months of 2025. I doubt the payroll-deduction plan is widely used anymore, so this may not affect many investors. Many employers, apparently, do not participate.

We know from recent “mysterious hints” from TreasuryDirect that changes could be coming to gift-box purchases of savings bonds, a purchase loophole that has been widely used in recent years as Series I Savings Bonds became attractive. And earlier this year, Treasury eliminated the ability to purchase paper savings bonds in lieu of a federal tax refund.

It seems odd that Treasury would eliminate the payroll-purchase program, which would appeal to ultra-small investors who might want to buy $100 lots of savings bonds at regular intervals. But, as I noted, this could be little used and a maintenance nightmare for the Treasury.

A lingering question would be: Is the zero-interest C of I being shut down completely? I doubt that, because this is where Treasury places funds with no known destination. This can happen when a user has incorrect banking information or no connected bank account. It is also where some investors briefly park money from maturing investments to await reinvestment.

And of course, some people are going to ask: Is Treasury preparing to close down the savings bond program entirely? I really don’t think so. That would be a disaster, because for many small-scale investors I Bonds are only easily accessible inflation-protected investment.

In addition, I Bonds and EE Bonds generally pay lower interest rates than most other Treasury investments, so the Treasury actually saves on borrowing costs by issuing savings bonds. Plus, actual payments to investors are usually deferred for many years.

As usual, Treasury could have done better with this communication. For example, it could have provided this information …

A simple alternative

If you were using the payroll deduction program and want to continue regular purchases of savings bonds, you can do this easily at TreasuryDirect.

First, log into your account and navigate to the “BuyDirect” page.
Select the savings bond you wish to purchase.
Then, in the “purchase frequency” section, set up repeat purchases. Options are weekly, biweekly, monthly, quarterly etc.

Reminder: Your total purchases for a calendar year can’t exceed the purchase limit of $10,000 per person per year.

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bonds: Here’s a simple way to track current value

• I Bond Manifesto: How this investment can work as an emergency fund

* * *

Follow Tipswatch on X (Twitter) for updates on daily Treasury auctions and real yield trends (when I am not traveling).

Posted in Cash alternatives, EE Bonds, I Bond, Investing in TIPS, TreasuryDirect | Tagged Treasury investments | 14 Comments

November inflation again ticked higher, to an annual rate of 2.7%

Posted on December 11, 2024 by Tipswatch

Troubling conclusion: U.S. inflation is no longer slowing and remains too high.

By David Enna, Tipswatch.com

Although annual U.S. inflation rose from 2.6% in October to 2.7% in November, financial markets are likely to view today’s report as a positive, because it matched expectations.

The U.S. Bureau of Labor Statistics reported this morning that both all-items inflation and core (which excludes food and energy) rose 0.3% in November. Those increases matched economist expectations, which – surprisingly – have been fairly accurate recently.

This isn’t exactly cause for celebration, as annual inflation remains too high and seems to be drifting higher. Core inflation has increased 0.3% in each of the last three months. But the stock and bond markets like predictable results. Stocks were up in premarket trading.

The BLS again pointed to shelter costs as a primary inflationary factor, with costs rising 0.3% for the month and 4.7% for the year. That increase, the BLS said, accounted for about 40% of the overall all-items increase. Also, gasoline prices increased 0.6% for the month, but have fallen 8.1% over the last year. The November increase broke a seven-month trend of declining gas prices. More from the report:

The costs of food at home increased 0.4% for the month and are up only 1.6% for the year. But the costs of dining out — food away from home — have increased 3.6% year over year.
Apparel costs were up 0.2% after falling 1.5% in October.
Costs of new vehicles rose 0.6% but are down 0.7% for the year.
Used car and truck prices rose a sharp 2.0% in November after rising 2.7% in October. But they are still down 3.4% year over year.
Airline fares rose 0.4% for the month and 4.7% for the year.
Costs of medical care services rose 0.4% in November and 3.7% for the year.
Motor vehicle insurance costs rose only 0.1% for the month but remain 12.7% higher for the year.

The BLS noted that price increases were widely spread across all major categories. Here is the trend for annual all-items and core inflation over the last 12 months:

This chart presents strong evidence that declines in U.S. inflation have ended, for the time being.

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates for I Bonds. For November, the BLS set the CPI-U index at 315.493, a decrease of 0.05% from the October number.

For TIPS. The November inflation report means that principal balances for all TIPS will decline by 0.05% in January, after rising 0.12% in November. It is normal to see deflationary non-seasonal numbers in November and December. For example, in 2023, non-seasonal inflation declined 0.2% in November and 0.1% in December.

This is likely to reverse course in January. Earlier this year, for example, non-seasonal inflation rose 0.54% January while adjusted CPI-U increased 0.3%. Here are the January inflation indexes for all TIPS.

For I Bonds. The November inflation report is the second in a six-month string that will determine the I Bond’s new variable rate, which will be reset May 1. So far, after two months, inflation has increased just 0.06%, which would translate to a variable rate of just 0.12%. This is meaningless. It’s too early to make any assumptions. Here are the data:

View historical data on my Inflation and I Bonds page.

What this means for future interest rates

Clearly, inflation remains too high and is not showing signs of falling. But the Federal Reserve has been signaling it is likely to go ahead with a 25-basis-point decrease in the federal funds rate next week. This report seems unlikely to change that plan.

This morning’s Bloomberg headline is right on target: “US CPI Brings No Surprises, Firming Up Fed Rate-Cut Bets.” From the coverage:

The report suggested that disinflation has essentially stalled in recent months. Headline CPI notched the first back-to-back annual acceleration since March, while core has been stuck at 3.3% — well above a figure consistent with the Fed’s 2% target for a separate price gauge, the PCE – for three months now. …

Shelter costs as usual made up the main portion of the rise in CPI, at almost 40%, although they did slow from the previous month. …

“Especially given the slowing in shelter, this should be very comfortable for the Fed to lower policy rates 25 basis points in December and continue cutting in 2025,” Citigroup Inc. economists Veronica Clark and Andrew Hollenhorst said in a note.

I agree that a 25-basis-point decrease seems likely next week, which would put the federal funds rate in the range of 4.25% to 4.50%, still comfortably higher than the annual U.S. inflation rate of 2.7%.

* * *

Follow Tipswatch on X (Twitter) for updates on daily Treasury auctions and real yield trends (when I am not traveling).

Posted in Cash alternatives, Federal Reserve, I Bond, Inflation, Investing in TIPS | Tagged business, economy, finance, inflation, investing, Treasury investments | 29 Comments

Real yields seem to have crested the peak. What’s next?

Posted on December 8, 2024 by Tipswatch

By David Enna, Tipswatch.com

It’s been an interesting month for financial investments of all types, as markets adapt to the launch of a second Donald Trump administration. Interesting, and very profitable for some speculative investors.

Some examples:

The S&P 500 stock index has surged 6.6% since Election Day on Nov. 5.
NASDAQ stocks are up 9.2% overall.
Bitcoin is up 49.5%.
Tesla shares are up 60.2%.
Software firm MicroStrategy, which has speculated on Bitcoin, is up 77.1%.
The stock of private prison firm CoreCivic is up 62.1%.
Palantir Technologies, a data analytics firm with expertise in counter-terrorism, is up 84.3%.

Some of these one-month increases are bordering on ridiculous. Speculators have been doing very well. That worries me as we enter a period of much easier regulation of giant financial firms. But even the low-volatility bond market has been doing okay, as interest rates have slipped from late-year highs. Vanguard’s Total Bond Market ETF is up 1.2% since Election Day, and the TIP ETF is up 0.82%.

Investors in Treasury Inflation-Protected Securities have seen the real yield curve both widen and then decline in the closing weeks of this year, with long-term TIPS getting higher yields than the shorter-term issues. Here is the year-to-date trend:

I highlighted the middle section of this chart, spring 2024, to show an optimal time for building a long-term ladder of TIPS investments. It is unusual to see high yields packed in a tight pattern. Investors could purchase individual TIPS of just about any maturity, 5 to 30 years, and get a real yield higher than 2.0%, a historically desirable number. See my post from June 9 and a more recent update on Nov. 10.

Here is a recap of real yields through the year, showing the high and low yields based on the 10-year term.

What we are seeing today is a “normalized” yield curve, and still attractive.

I’d expect the 5-year real yield to decline (a bit) as the Federal Reserve continues to cut short-term interest rates. The Fed will announce a decision Dec. 18, a week after we get the November inflation report (Dec. 11) and one day before a 5-year TIPS reopening auction (Dec. 19).

It seems highly likely the Fed will cut its federal funds rate by 25 basis points to a range of 4.25% to 4.50%. Last week’s 4- and 8-week T-bill auctions seemed to signal the market’s belief a cut is coming. The 4-week came in at 4.476%, down from the week earlier’s 4.630%. The 8-week was also down at 4.440%.

So for the time being, we could see slightly lower real yields in the 5- to 10-year range, but somewhat more stable real yields in the 20- to 30-year range. The upcoming inflation report could also swing the market. Barron’s is forecasting an CPI-U increase of 0.3% for October, which would indicate inflation is not steadily sliding lower.

I don’t see mid- to longer-term real yields declining dramatically in the near term. Do TIPS remain attractive investments? I think so in a time of economic uncertainty.

What comes next

Wednesday, Dec. 11. I will be posting an analysis of the November inflation report and its effect on TIPS and I Bonds. Even if seasonally-adjusted inflation comes in at 0.3%, you can expect the non-seasonally number — which affects TIPS and I Bonds — to be lower. In November 2023, official CPI-U rose 0.1% while non-seasonal was down 0.2%.

If November inflation ends up in the expected range, stock market investors will probably yawn and continue the Santa Claus/Trump rally.

Sunday, Dec. 15. I will post a preview article on the upcoming reopening auction of a 5-year TIPS, CUSIP 91282CLV1. Prediction: The real yield could end up being quite close to the originating auction‘s 1.670%, or a bit lower.

Wednesday, Dec. 18. The Federal Reserve will announce its decision on short-term interest rates. I won’t be writing about that, unless something wild happens.

Thursday, Dec. 19. I’ll post the results and an analysis of the 5-year TIPS reopening auction.

Thursday, Jan. 2. I am hoping for some guidance from the Treasury on the status of gift-box purchases of I Bonds. I delivered two sets in 2024. At the least I hope to see — possibly — if I am locked out of purchases in 2025.

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• TIPS investor: Don’t over-think the threat of deflation

• Upcoming schedule of TIPS auctions

* * *

Follow Tipswatch on X (Twitter) for updates on daily Treasury auctions and real yield trends (when I am not traveling).