Treasury Inflation-Protected Securities

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.

 

Even if you want to accumulate a portfolio of Treasury Inflation-Protected Securities, there is one big issue when it comes to this 30-year TIPS, Cusip 912810QP6:

Is 30 years too long?

My philosophy is simple: Buy TIPS at TreasuryDirect.gov (or in a retirement account) and hold them to maturity. In my view, putting 25% of your money into TIPS and I Bonds – not mutual funds, the real thing – is an ultra-safe, sensible investment. The rest of that portfolio can be diversified into dividend-paying stocks, stock mutual funds, other bonds, TIPS mutual funds, real estate, etc.

TIPS and I Bonds play two important roles: 1) They are the unshakable ballast of your portfolio. They will not go down. They will pay off at maturity. They will provide a real gain until then. And, 2) they are insurance against future inflation.

But 30 years?

PROS AND CONS OF THE 30-YEAR REISSUE

Pros

1) The auction yield should be around 1.8%, probably a bit higher. This is 110 basis points higher than the going rate on a 10-year TIPS, and a whopping 230 basis points higher than a 5-year TIPS. You will get that yield for 30 years, on a principal base that is constantly increasing with inflation.

The one good thing about 1.8% is that it will give your overall portfolio of TIPS a bit higher yield, balancing out some recent purchases, like the 5-year TIPS at negative 0.18%.

2) Inflation might not be a near-term threat, but it could be a threat – even a severe threat – in the next 30 years. This is a hedge against that threat. Can your bank CD promise the same?

3) Safety is high, when measured against other investments, at least.

Cons

1) That yield is not great. In fact, this TIPS was first issued four months ago with a base rate of 2.19%. It is likely that the TIPS rates will begin – eventually – moving more toward ‘normal’ levels, and for a 30-year that would be nearly 3%. However, I have been saying that for quite awhile, and I have been wrong.

This 30-year TIPS will be reissued again on Oct. 20, so you could park your money and wait it out, hoping for a higher yield in October.

There are two reasons that people buy 5-year TIPS at negative real yields: 1) They expect inflation to be higher than expected, and 2) It’s only five years.

This one is 30 years. You will be looking at it a long time in your portfolio.

On the other hand, if recent trends continue, we may someday look at 1.8% as an attractive rate. Unlikely.

2) Safety could reasonably become an issue in the next 30 years, as we are watching happen in Greece this week. The safety of U.S. Treasuries cannot be questioned, until you really start thinking about it. I don’t like going there.

3) 30 Years. It’s a long time.

CONCLUSION

Yes, I will invest in this TIPS, but I will reserve some funds for the upcoming 10-year and 30-year auctions of 2011. In other words, don’t bet the house on this one.

6/23 update: This 30-year TIPS was auctioned at a rate of 1.744%, which was indeed a record low for a 30-year issue.

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The U.S. Treasury on June 23, 2011, will offer a 29-year, 8-month Treasury Inflation-Protected Security in a reopening of Cusip 912810QP6, which was first issued in February 2011. This same TIPS auctioned four months ago with a yield of 2.190%.

(The TIPS yield is a base number. In addition, for the life of the issue, your principal increases by the the rate of consumer inflation. So over time, both the principal and the interest you receive will increase, as long as the CPI rises.)

Right now, a week from the auction, it looks like this TIPS will auction off with a base yield of around 1.75%, (see updates below) which could end up being the lowest rate in history for a 30-year TIPS. (However, I need to point out that the Treasury stopped offering 30-year TIPS from Oct. 15, 2001 – when the base rate was 3.465% – until Feb. 15, 2010 – when the base rate had fallen to 2.229%.)

Pretty crafty work by the Treasury, to be locking up these much lower rates for 30 years.

I thought it would be interesting to look back at the rate of past 30-year TIPS auctions:

Go ahead, look longingly at those rates around 4% from 10 years ago. They are history. Will this June 23 auction bring a record-low base rate? Possibly not, since a similar reissue last Aug. 23 generated a yield of only 1.768%.

I ‘feel’ like this auction rate will end up being slightly higher. We will know more next week.

6/17 update: The market rate on this 30-year TIPS rose slightly on Thursday to 1.766%, still slightly below the lowest auction ever.

6/18 update: On Friday, the yield rose nicely to 1.815%. This issue is starting to look more attractive heading into next week’s auction.

6/21 update: On Monday, the yield rose again to 1.831%.

6/22 update: On Tuesday, the yield fell to 1.804%.

6/23 update: On Wednesday, the yield rose to 1.828%. My thinking is that should indicate an auction rate Thursday of 1.85% or higher, unless there is a shakeup in the markets.

If you are interested in buying this issue, check out the details on TreasuryDirect.gov. Noncompetitive bids will be accepted until noon, June 23.

Note: I have posted updates on the 30-year TIPS’ likely yield

Next week, on June 23, the U.S. Treasury will auction a reissue of 30-year Treasury Inflation-Protected Securities. The formal announcement came today: It is a 29-year, 8-month issue, meaning it is Cusip 912810QP6, which was first issued in February 2011.

February 2011 … so long ago … you might not remember that this TIPS auctioned four months ago with a real yield of 2.130%. It has a coupon rate of 2.125%.

In only four months … The real yield on TIPS has declined sharply, mainly for this reason: A rising fear of inflation. When inflation fears rise, investors are willing to pay more for TIPS, and accept a lower real yield, because TIPS investors ‘benefit’ from higher-than-expected inflation. The other contributing factor is turmoil in Europe over the potential for a Greek default. That pushes investors toward the safety of U.S. Treasuries.

On Wednesday, we got a double whammy: The May CPI number came in higher than expected, and fears spiraled that Greece will default on its debt.

And this was the result at Wednesday’s end:

The likely yield on the 30-year TIPS to be issued June 23 declined sharply – now sitting around 1.757% – reversing a positive trend in yield that was making next week’s auction more appealing.

Here was the yield at the end of Tuesday:

So in one day, the yield dropped 0.056%. Like I said … ouch.

Keep in mind that four long months ago, you could have bought this 30-year TIPS with a real yield of 2.13%, with any future inflation building your principal over 30 years.

Makes you sort of nostalgic for the long-lost days of February.

At this point … I still would not rule out investing in this 30-year TIPS reissue, but I think it’s important to keep an eye on the potential yield. If it rises back toward 2%, this TIPS is a lot more attractive.