Treasury Inflation-Protected Securities

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%.

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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 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

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

Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS, Treasury Bills | Tagged bonds, economy, inflation, investing, personal-finance, Treasury investments | 14 Comments

IVOL, a once-hot inflation-fighting ETF, has produced poor results

Posted on November 24, 2024 by Tipswatch

By David Enna, Tipswatch.com

My philosophy of investing is pretty simple: Stick to your asset allocation, layer in some inflation protection, and avoid undue risk, especially in your fixed-income holdings.

So for fixed income, I am a fan of low-cost, intermediate-term funds like Vanguard’s Total Bond, paired with holdings of I Bonds, individual TIPS, nominal Treasurys and CDs. Safety is the key. That is my approach. And I take a skeptical approach to anything “new and improved.”

Back in the fall of 2020, I was getting a lot of questions about a new ETF with a tongue-twisting title: the Quadratic Interest Rate Volatility and Inflation Hedge ETF. Everyone knew this fund by its ticker: IVOL.

The ETF’s creator, Nancy Davis of Quadratic Capital, was hailed as an innovator for this fund. Barron’s named her one of its top 200 Women in Finance in March 2020. But for me, IVOL was never particularly attractive. It was very new, with just a year of trading history. It was a fixed-income fund with a 1% expense ratio and a complex hedging strategy I couldn’t understand. Some readers disagreed with me back in August 2020:

The author does not like IVOL because of reasons such as “too new” and “expense ratio.” But you can look at the results and decide for yourself… Since the March 2020 lows for TIPS in general IVOL has out-performed the ETF-TIP.

I look at the results of a fund — yield, price growth, volatility and drawdown. So far so good with IVOL on all four. If a fund is performing well, I have no problem paying a higher expense ratio.

The interesting thing about IVOL is that it holds about 85% of its assets in SCHP, Schwab’s U.S. TIPS ETF, a high-quality full-maturity-spectrum TIPS fund. On top of that, it overlays hedging strategies that seek to benefit from interest rate volatility. Quadratic’s information on the fund includes this summary of its strategy:

IVOL is a fixed income ETF that seeks to hedge relative interest rate movements, whether these movements arise from falling short-term interest rates or rising long-term interest rates, and to benefit from market stress when fixed income volatility increases, while providing the potential for enhanced, inflation-protected income.

Since IVOL launched in May 2019, we’ve certainly had a lot of interest rate volatility, both up and down. For a time during the early days of the Covid pandemic, IVOL benefited from interest rates falling dramatically. But then in 2022, the Federal Reserve began raising interest rates aggressively.

Rising interest rates aren’t good for any bond fund, but IVOL was especially hard hit in the last two years, as shown in this chart:

Remember, IVOL holds 85% of its assets in SCHP, but has an expense ratio about 34x higher than SCHP, 1.02% versus 0.03%. Here is a comparison of the total return for IVOL over the last five years versus SCHP, the total bond market ETF (BND) and Vanguard’s short-term TIPS ETF (VTIP).

In a year when bond funds have been rising in total return, IVOL’s total return, including payouts, has declined 10.2% in 2024 and is much worse across 1-, 3- and 5-year periods. My conclusion: IVOL’s hedging strategy didn’t work in a rising interest rate environment.

Why was it so hot four years ago? Because in 2020 it had a total return of 14.6%, versus 10.9% for SCHP. Investors saw that and flooded into the fund. During that time, IVOL’s assets under management surged to $3.5 billion. Today, that is down to $547 million. Morningstar gives the fund a “negative” rating, noting:

Fees are a weakness here. The strategy’s lofty fees are a high hurdle to clear. … Over the past three years, it trailed the category index, the Bloomberg Barclays U.S. Treasury Inflation-Protected Securities Index, by an annualized 7.7 percentage points.

The lesson

It is smart to be dull. I try to keep my investment allocation simple and want safety and predictability in my fixed-income investments. When something “new” and “better” and “smarter” comes along, I am highly skeptical. Let’s see how it performs over time.

IVOL was touted in 2020 as the “great new idea” for inflation protection, but it hasn’t delivered. It was supposed to gain from volatility, but instead did poorly at a time of high volatility. The high expense ratio and untested hedging strategies didn’t work for investors.

At this point, I have no investments in any TIPS funds or ETFs. Over recent years, the one fund I have recommended (if anyone asks) is Vanguard’s Short-Term TIPS, VTIP, which has low volatility and therefore tends to track inflation better. There are no tricks to that fund. It has a 4-star gold rating on Morningstar, which says: “Great inflation protection at a low cost.”

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

Posted in ETFs, Inflation, Investing in TIPS | Tagged inflation, interest-rates, investing | 19 Comments

10-year TIPS reopening auction gets real yield of 2.071%

Posted on November 21, 2024 by Tipswatch

By David Enna, Tipswatch.com

The Treasury’s reopening auction of a 10-year Treasury Inflation-Protected Security — CUSIP 91282CLE9 — generated a real yield to maturity of 2.071%, right in line with where this TIPS was trading this morning on the secondary market.

This TIPS has a 9-year, 8-month term and carries a coupon rate of 1.875%, which was set by the originating auction on July 18. Shortly before the auction’s close it was trading on the secondary market with a real yield of 2.07%, so the result looks on target. But the “when-issued” prediction was 2.05%, so demand might have been a bit weak. The bid-to-cover ratio was 2.35, also a bit weak.

In a short article on the auction, Marketwatch noted it produced “lackluster results.”

However, for investors, a real yield of 2.071% looks like a good result. An earlier reopening for this TIPS, on Sept. 19, got a much lower real yield of 1.592%.

Here is the trend in the 10-year real yield over the last 14 months, showing the peak in October 2023 and the recent surge higher:

Pricing

Because this TIPS auctioned with a real yield higher than its coupon rate, investors got it at a discount, an unadjusted price of 98.295224. In addition, it will carry an inflation index of 1.00473 on the settlement date of Nov. 29. With that information, we can calculate the cost of a $10,000 par investment:

Par amount: $10,000.
Principal on settlement date: $10,000 x 1.00473 = $10,047.30
Cost of investment: $10,047.30 x 0.98295224 = $9,876.02
+ Accrued interest of $70.13

In summary, an investor purchasing $10,000 par of this TIPS paid $9,876.02 for $10,047.30 of principal on the settlement date on Nov. 29. From that point on, the investor will receive annual interest of 1.875% on adjusted principal, which will grow with future inflation.

Inflation breakeven rate

With the 10-year nominal Treasury note yielding 4.42% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.35%, a bit higher than recent results. This reflects growing uncertainty about future inflation at a time of a strong economy, strong stock market and very high U.S. budget deficits.

Here is the trend in the 10-year inflation breakeven rate over the last 14 months, showing the sharp upward trend in the two months leading to the U.S. presidential election:

Reaction to the auction

This was a good result for investors, easily clearing the coveted real yield threshold of 2.00%. Since January 2009, there have been 92 TIPS auctions of this term and only four have generated a real yield higher than 2%. Real yields could certainly continue going higher, but for a buy-and-hold investor a yield higher than 2.0% looks like a solid investment.

This was the last TIPS auction of this term for 2024. A new 10-year TIPS will be auctioned on January 23, 2025. Here are results for recent auctions of this term:

• 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

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

Posted in Inflation, Investing in TIPS | Tagged bonds, economy, finance, inflation, investing, investment, personal-finance, Treasury investments | 16 Comments

Thursday’s 10-year TIPS auction will benefit from surge in real yields

Posted on November 17, 2024 by Tipswatch

By David Enna, Tipswatch.com

Reality is beginning to settle in on the U.S. bond market. Even as the Federal Reserve continues to cut short-term interest rates, longer-term yields have been rising in recent weeks as the market:

Calculates the potential deficit risks of a Trump presidency.
Figures the possible effect of tariffs on U.S. inflation.
Observes a decently strong U.S. economy and labor market.
Ponders why risky asset classes like Bitcoin have surged 34% higher in two weeks.
And beyond all that, sees the U.S. Treasury continuing to borrow a lot of money.

As a result, mid- to longer-term Treasury yields have been rising over the last several weeks, as shown in a 56-basis-point rise in the 10-year real yield since mid-September. This surge could continue because the bond market is dealing with uncertainty. Bond investors don’t like uncertainty.

Amid this drama, the Treasury on Thursday will offer $17 billion in a reopening auction of CUSIP 91282CLE9, creating a 9-year, 8-month Treasury Inflation-Protected Security. Some history:

July 18. The originating auction for this TIPS got a real yield to maturity of 1.883%, which set its coupon rate at 1.875%, the highest coupon for this term since July 2009.
Sept. 19. The first reopening auction got a much lower real yield of 1.592%, the day after the Federal Reserve made a surprise decision to cut short-term interest rates by 50 basis points.

Now, two months later, the 10-year real yield has surged to 2.10%. CUSIP 91282CLE9 trades on the secondary market, and this weekend I am seeing price quotes right in the 2.10% range. Of course, things will change a bit before Thursday’s auction. An investor in this TIPS can also buy it at any time on the secondary market, of course.

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 2.10% means an investment in this TIPS would provide a return that exceeds U.S. inflation by 2.10% for 9 years, 8 months.

Here is the trend in the 10-year real yield over the last 15 years, showing that while yields are off the highs of October 2023, they remain in a historically high range:

As for the future, who knows? It’s in the realm of possibility that 10-year real yields could climb to somewhere around 3% (as we last saw in January 2003). That seems unlikely, but if deficits soar while the U.S. economy is surging it could happen. However, if the economy dips into recession, both nominal and real yields will decline.

In the 15-year chart above, note the tiny shaded area indicating the very brief pandemic-triggered recession in 2020. One brief recession in 15 years is rather amazing. So … are we due?

Pricing

At Friday’s close, this TIPS was trading with a discounted price of 98.02. It is discounted because the real yield of 2.10% is above the coupon rate of 1.875%. In addition, it will have an inflation index of 1.00473 on the settlement date of Nov. 29. With that information, we can estimate the investment cost of a purchase of $10,000 par value:

Par value: $10,000
Actual principal purchased: $10,000 x 1.00473 = $10,047.30
Cost of investment = $10,047.30 x 0.9802 = $9,848.36
+ accrued interest = About $70.

In summary, the investor would pay $9,848 for $10,047 of principal and then receive inflation accruals plus an annual coupon payment of 1.875% for the next 9 years, 8 months. The accrued interest would be returned at the first coupon payment on Jan. 15. This is an estimate and conditions will change by Thursday.

Inflation breakeven rate

With the 10-year Treasury note closing Friday with a nominal yield of 4.43%, this TIPS currently has an inflation breakeven rate of 2.33%, higher than recent auctions of this term. Not a big surprise … this reflects the market’s uncertainty about future inflation. Over the last 10 years ending in October, inflation has averaged 2.9%, the highest 10-year rate since 1999.

A simple rule for me is that a higher inflation breakeven rate indicates that a TIPS is “more expensive” versus the nominal Treasury. In this case, I have to admit, a 10-year Treasury note paying 4.43% looks pretty attractive. But I’d still prefer to invest in the TIPS to get the future inflation protection.

Here is the trend in the 10-year inflation breakeven rate over the last 15 years, showing that the current rate of 2.33% is in the “highish” zone:

Some thoughts

I bought this TIPS on the secondary market on Oct. 29 with a real yield of 2.008%, so I am not in the market to buy more. I am now awaiting the auction of a new 10-year TIPS on Jan. 23, 2025. That TIPS will be my first (and possibly only) purchase for the 2035 rung of my TIPS ladder.

If you have a brokerage account, you can buy this TIPS at auction this week, or any time on the secondary market when you see a real yield you like. The advantage of the auction is that small purchases (the minimum is only $100 at TreasuryDirect) get the high real yield, but you won’t know the yield until the auction completes. The advantage of the secondary market is you can see the exact yield you are purchasing, but you may face a small penalty for buying in a small amount.

In my opinion, any 10-year TIPS with a real yield of 2%+ is attractive. It is a good target for investing. If you are buying at auction, you can follow the real yield of this TIPS on the secondary market on Bloomberg’s Current Yields page. Both the bond and stock markets are volatile right now, so things can change.

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: