Treasury Inflation-Protected Securities

Mihir Worah, PIMCO portfolio manager, is discussing inflation and TIPS in a new economic outlook titled, ‘Higher Commodity Prices and the End of Economic Growth Without Inflation‘.

Worah is manager of the $19.8 billion Pimco Real Return Fund (PRRIX),  which has about 78% of its investment in Treasury Inflation-Protected Securities.

Here are some excerpts:

Commodity prices are rising. Given the global supply/demand imbalances that we see, we expect commodity prices to be generally rising going forward, noting, of course, that commodity prices are volatile and that there will be differentiation among commodities. Much of this is related to the dynamics in and between developed and emerging economies. …

Inflationary pressure from commodities will be even higher within emerging markets. The reason: commodities are such a large part of their consumption basket – for example, nearly 60% in India, compared to about 25% in the U.S. …

Currency issues. Currencies may become another strong driver of inflation, especially among developed economies. We anticipate policymakers in the developed world will attempt to make their economies more competitive via a cheaper currency, which likely will, for net importers like the U.S., lead to higher inflation. …

Finally, in our view, the biggest implication for the global economy of these dynamics is that the goldilocks days of the ’90s where nations could have strong growth and low inflation simultaneously are gone.

Worah goes on to endorse Treasury Inflation-Protected Securities as a hedge against rising inflation. (Remember, however, that he manages a fund that specializes in TIPS, so he has an interest in promoting them.)

To be sure, there is currently a valuation issue with inflation-linked bonds as real rates on such bonds are low. But we believe those rates are likely to stay low – one way for developed markets to escape from their debt overhang is by artificially keeping real rates low, either through regulation or through higher inflation via inflationary/low-rate policies. So in our view, inflation-linked bonds have the potential to hold their value while serving as a cornerstone of an inflation-hedging strategy. …

Investors should seek out prudently managed active strategies that provide the benefits of inflation-linked bonds while attempting to enhance the offered yields.

Update: Yes or no on this 10-year TIPS auction?

Buyers of Treasury Inflation-Protected Securities used have have to wait months for new auctions, but now they seem to come every month. And in fact … they do … you will have a TIPS buying opportunity every month for the rest of this year.

Next up  is a new-issue 10-year TIPS. The announcement will come July 14, and the auction is July 21, 2011. It will settle July 29. This is the last new issue of the year, the rest are reissues. Here is a 2011 schedule presented on ExploreBonds.com:

N = a new issue that hasn’t been on the market before
R = a reopening of a bond sold in a previous auction

10-year TIPS, what to expect? Not much in the way of yield, unfortunately. Right now, a 10-year TIPS sold on the open market would net a yield-to-maturity of about 0.620%, plus the inflation adjustment to principal. That’s near historic lows, and … not very exciting.

The last 10-year reissue, issued on May 31, 2011, auctioned at a base yield of 0.887%. I was a buyer of that one, and I will probably hold my nose and buy the July new issue, in a small amount.

10 years, the sweet spot? Not sweet in yield, that is certain. Ten-year TIPS traditionally yield about 2% above inflation.

But if you are laddering TIPS, 10 years is a great number. Possibly you will be retired in 10 years? Then, when this TIPS pays out, you will have the option to keep the proceeds and spend it, or reinvest it however you wish. If you have a lineup of 10-year TIPS, you will have this option every year in retirement.

I want to keep a supply of TIPS paying out into the future.

Fed Chairman Ben Bernanke saved the U.S. Treasury a lot of money with his speech on Wednesday, saying the economy remains weak and the Fed has no plan for a major stimulus program. The stock market took an immediate dive, and that continues today, with the Dow Jones Industrial Average down about 1.25% as of 1 p.m. today.

Against that woeful backdrop, the TIP ETF is up 0.5% today.

And so the Treasury’s reissue of a 30-year TIPS, Cusip 912810QP6, went off without a hitch — for the Treasury, that is. The resulting yield was 1.744%, solidly lower than the 1.85% that looked likely yesterday.

And yes, that is a record low for any 30-year TIPS auction. (A similar reissue last Aug. 23 generated a yield of  1.768%, the previous low.)

Didn’t see that coming …

From the Dow Jones report:

“This represents … the demand for long maturity TIPS, or rather the desire to get out of short maturity TIPS,” said Richard Gilhooly, director of interest rate strategy at TD Securities. “Short TIPS outperformed massively in recent months due to surging oil … now oil is plunging and the exodus from short TIPS is not yet over.”

And Dow Jones on the sharp drop in Treasury yields on Thursday:

Investors’ seemingly insatiable hunger for financial safe havens Thursday dragged two-year Treasury yields near an all-time low and briefly pushed yields on shorter-term bills into negative territory–suggesting buyers were even willing to pay the government to lend it money….

Near the end of the U.S. trading day, two-year yields touched 0.334%–the lowest level this year and close to the all-time low of 0.316%, booked on Nov. 4. …

Thursday afternoon, The Treasury Department sold $7 billion in re-opened 30-year Treasury Inflation Protected Securities at 1.744% amid the strongest demand, a bid-to-cover ratio of 3.02, in the history of 30-year TIPS sales.