Thursday’s 10-year TIPS auction could mark trend of lower yields

Posted on July 14, 2024 by Tipswatch

By David Enna, Tipswatch.com

The U.S. Treasury on Thursday will offer $19 billion in a new 10-year Treasury Inflation-Protected Security, CUSIP 91282CLE9. The coupon rate and the real yield to maturity will be set by the auction’s results.

This will be an interesting auction because last week’s inflation report for June showed deflation of -0.1% for all-items prices, and that triggered the 10-year real yield to fall to 1.94% at Friday’s close, the lowest level since March 28. The 10-year real yield has fallen 34 basis points since hitting a 2024 high of 2.28% on April 30.

It’s impossible to say where real yields will be heading this week. The bond market has been volatile, but the apparent cooling of the U.S. economy, combined with weakening inflation and a more dovish Federal Reserve could send yields even lower.

Definition: A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So, the “real yield to maturity” of a TIPS indicates how much an investor will earn above inflation each year until maturity.

Facts about this auction:

  • The auction size of $19 billion is the largest in the history of the Treasury’s 10-year TIPS offerings. It’s about 12% higher than a similar auction in July 2023. Could increasing auction sizes result in weaker investor demand? So far, that hasn’t been the case.
  • This TIPS will carry an inflation index of 1.00086 on the settlement date of July 31. That amounts to just $8 on a $10,000 investment, so it is likely that this new TIPS will auction with an investment cost close to — or just below — par value of 100, even with the additional principal added in.
  • At this point it would appear the auctioned real with to maturity will be somewhere around 1.94%, which was the Treasury’s yield estimate at Friday’s close. That would set the coupon rate at 1.875%. The Treasury updates its estimate at each market close on this page.

Here is the trend in the 10-year real yield over the last four years, showing that yields remain at attractive levels even after the recent decline:

Click on image for larger version.

Inflation breakeven rate

The Treasury estimates the nominal yield of a 10-year Treasury note closed Friday at 4.18%, which creates an inflation breakeven rate of 2.24% for a new 10-year TIPS, based on data from Friday. Things will change before the auction, but a breakeven rate of 2.24% would be the lowest for this term since July 2022.

The breakeven rate is important because it sizes up the TIPS versus a nominal Treasury. If you think inflation will average more than 2.24% over the next 10 years, you buy the TIPS. If not, you would favor the nominal Treasury.

Here is the trend in the 10-year inflation breakeven rate over the last four years:

Click on image for larger version.

Thoughts

It’s impossible to know where real yields are heading. The current trend seems to point to lower yields, but this is a volatile market. I believe a 10-year real yield around 1.94% remains attractive. Last year, the July 2023 auction of a new 10-year TIPS resulted in a real yield of 1.49%, well below the current market.

I won’t be a buyer because I have already filled the 2034 rung of my TIPS ladder with purchases of the January 10-year, CUSIP 91282CJY8. My initial purchase in January got a real yield of 1.810%, so 1.94% doesn’t look bad.

If you are thinking of investing in this TIPS, you can track the Treasury’s yield estimates here and see real-time yields for the January 2024 TIPS here. This TIPS auction closes Thursday at 1 p.m. ET. 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 plan on posting the auction results sometime Thursday (but I am in Alpine Europe and I can’t be sure when that will happen.)

Here is the history of 9 – to 10- year TIPS auctions over the last four years:

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• 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.

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 , , , , , , | 7 Comments

In a surprising turn, inflation turned to deflation in June

Posted on July 11, 2024 by Tipswatch

For the markets and the Fed, June’s inflation report was positive news.

By David Enna, Tipswatch.com

As soon as I arrived in Geneva, Switzerland, this afternoon, I began looking for news on the June inflation report. My arrival was timed — not by choice — close to the release by the Bureau of Labor Statistics at 8:30 a.m ET.

The news was surprising: The Consumer Price Index for All Urban Consumers declined 0.1% on a seasonally adjusted basis, after being unchanged in May, the BLS reported. Annual inflation fell from 3.3% in May to 3.0% in June. Core inflation, which removes food and energy, rose 0.1% for the month and 3.3% for the year, down from 3.5% in May. This was the smallest 12-month increase in core inflation since April 2021.

All of these numbers were below consensus estimates, indicating that inflation could be slowing a bit more than economists — and even the Federal Reserve — had been anticipating. June’s deflation was slight, only negative 0.1%, but the annual rate dipped for both all-items and core inflation.

Gasoline prices, which fell 3.8% in June, again were an important factor in the decline in all-items inflation. Gas prices are now down 2.2% for the year. Shelter costs rose a reasonable 0.2% in June, but are up 5.2% over the last year. Food at home costs rose 0.2% for the month and are up 2.2% over the last year.

Here is the trend in all-items and core inflation over the last 12 months showing the recent disinflationary pattern:

In my opinion, this is exactly the trend, at least since March, that the Federal Reserve has been hoping to achieve.

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 June, the BLS set the inflation index at 314.175, an increase of just 0.03% over the May number.

For TIPS. The June inflation report means that principal balances for all TIPS will rise 0.03% in August, after rising 0.17% in July. Here are the new July Inflation Indexes for all TIPS.

For I Bonds. The June report is the third in a six-month string that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on November 1 and eventually roll out to all I Bonds, depending on the original month of purchase.

As of June, inflation has increased only 0.59% over the three months, which would translate to an I Bond variable rate of 1.18%, a disappointing number. But three months remain. A more likely scenario would bring the variable rate up to around 1.80%, still well below the current rate of 2.96%. I Bonds could be a tough sell in November, especially if the permanent fixed rate slips lower than the current 1.3%.

Here are the data so far:

What this means for future interest rates

The Federal Reserve faces an interesting dilemma. I watched Chairman Jerome Powell testify before Congress earlier this week, and he was repeatedly lectured by Republicans to avoid the “optics” problem of cutting interest rates just before the 2024 presidential election. Powell sidestepped that question.

I still think a September rate cut of of 25 basis points is possibility. From today’s Wall Street Journal report:

After the release of the report, investors dialed up bets that the Fed would cut rates twice this year, and the odds of a third cut climbed, implying the central bank could lower rates at its last three meetings of the year, in September, November, and December.

And here is commentary from inflation analyst Michael Ashton:

Overall, there’s no doubting that this number is soothing for the Fed. It’s soothing for me too. Inflation is decelerating, and as I said last month I think the Fed will almost certainly deliver a token ease in the next couple of months. …

The potential issue is that inflation isn’t slowing for the reason the Fed thinks it is. The economy is slowing, and unemployment is rising. … An ease will follow shortly. Whether that is followed by further eases remains to be seen, but…for now…the trends are favorable for the central bank.

And now, I am going to restart my vacation.

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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.

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, I Bond, Inflation, Investing in TIPS, Savings Bond | Tagged , , , | 6 Comments

My schedule … and what’s coming up

Posted on July 9, 2024 by Tipswatch
Julie Andrews in “The Sound of Music.” 1965, 20th Century-Fox. Much of the filming was done around Salzburg, Austria. I just re-watched it. Fantastic.

By David Enna, Tipswatch.com

Here we go again. Yes, I am traveling again for the next three weeks through the European Alps: Switzerland, France, Italy and Austria.

Much of the time I will be in mountain cities or villages, and may not have strong Internet connections. (But this is Europe, so maybe?) I will attempt to keep up with financial news and reading & answering your comments, but no promises. My article updates will be spotty and ill-timed, I expect.

This will be a fairly busy time for news, especially with potential decisions coming on one U.S. presidential candidacy and one vice presidential choice. And it’s a fine time to view simmering political chaos in Europe.

What’s ahead?

Thursday, July 11. The Bureau of Labor Statistics will release the June inflation report at 8:30 a.m. EDT, or 2:30 p.m. CEST in Geneva, which is on Central European Summer Time. This is about the time I will be arriving in Geneva, so this report will be delayed, along with the effects of impending jet lag.

The consensus of economists is for fairly mild monthly inflation for June, with the annual inflation rate falling from the current 3.3% to 3.1%. But core inflation is expected to tick higher, from 3.4% to 3.5%.

The June inflation report is especially interesting because it sets a baseline for the upcoming increase in the Social Security COLA, which is based on the average of July to September readings in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). I may try to provide a projection of next year’s increase, but that’s a complicated task. It may have to wait until after I return.

Sunday, July 14. I am planning to post a preview article on the auction of a new 10-year Treasury Inflation-Protected Security, scheduled for Thursday, July 18. Real yields have been quite volatile recently, especially in the aftermath of the June 27 presidential debate. But things have settled down, and real yields have been moving lower. The market closed Friday, July 5, with the 10-year real yield at 2.00%, down 16 basis points for the week.

Thursday, July 18. The 10-year TIPS auction closes at 6 p.m. CEST in Biella, Italy, where I will be on that date. There is a good chance my schedule will be complicated at that hour, so I will post the auction results when I can.

Sunday, July 21. I will post a TIPS vs. Nominals article on the 10-year TIPS that is maturing on July 15. This TIPS, which I own, has continued the streak of TIPS out-performance.

At this point, that is all I can see, but something always comes up when I am on vacation.

* * *

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.

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 Inflation, Investing in TIPS, Retirement, Social Security | 7 Comments

Debate aftermath: Barclays says buy inflation protection

Posted on June 30, 2024 by Tipswatch

By David Enna, Tipswatch.com

Any long-time reader of this site knows I try very hard to avoid political discussions and I discourage political rants in the comments section. This is a site about inflation protection and investing with a focus on safety.

Thursday night’s presidential debate was difficult to watch, no matter your political persuasion. Did we get actual policy discussions? No. The solvency of the Social Security system was raised by the moderators, but we got in essence, nothing of substance from the two debaters.

But I was interested to see a report Friday from Bloomberg that combined inflation and inflation protection into the debate analysis. This was the headline, and you can read the article free on Yahoo! Finance: “Barclays Says Buy Inflation Protection to Prepare for Trump Win.”

It is based on a research report from Barclays Plc. From the Bloomberg report:

With former president Donald Trump appearing more likely to unseat Joe Biden in the Nov. 5 election, the market should “be pricing in a considerable risk of higher-than-target inflation in the coming years, and this is from a starting point of our thinking they already offered structural value,” Barclays strategists Michael Pond and Jonathan Hill said in a note.

The simple trade, they wrote, is a wager that five-year Treasury inflation-protected securities, or TIPS, will outperform regular five-year Treasuries, leading to a wider yield spread between the two. That breakeven rate — representing the market-implied expectation for the average inflation rate of the consumer price index over the life of the securities — will widen to 2.5% from about 2.25% currently, Barclays projects.

Click on image for larger version.

The reasoning

The authors point to former President Trump’s proposed 10% tariffs on all imports, and likely even higher tariffs for imports from China. In addition, his plan for an aggressive effort to deport illegal immigrants could trigger labor shortages and wage inflation. He has also proposed across-the-board tax cuts, which would add to the U.S. deficit and potentially stimulate consumer spending.

(I)f the odds in the coming months continue to favor a second Trump term, “we would expect them to be embedded in the market via higher breakevens as the November elections approach,” Pond and Hill wrote.

A similar analysis was recently laid out in a letter published by 16 prominent economists, all Nobel Prize winners. They wrote, “The outcome of this election will have economic repercussions for years, and possibly decades, to come.” You can read that here.

You can read a detailed analysis of import tariffs imposed by Trump and continued by Biden in this report from TaxFoundation.org. From that report:

As of March 2024, the trade war tariffs have generated more than $233 billion of higher taxes collected for the US government from US consumers. Of that total, $89 billion, or about 38 percent, was collected during the Trump administration, while the remaining $144 billion, or about 62 percent, has been collected during the Biden administration.

Along the same lines, noted bond investor Bill Gross recently told the Financial Times that he believes a Trump victory would be “more bearish” and “disruptive” for the bond markets than the re-election of Biden.

“Trump is the more bearish of the candidates simply because his programs advocate continued tax cuts and more expensive things,” Gross said, although he noted that Biden’s presidency had also been responsible for trillions of dollars of deficit spending.

My analysis

I have been saying for several months that inflation breakeven rates seem overly optimistic, making an investment in a Treasury Inflation-Protected Security (current 5-year real yield of 2.09%) more attractive than its matching nominal Treasury (4.33%). And history is on my side. Inflation over the last 5 years, ending in May, has averaged 4.2%. And that is why we have seen a string of favorable returns from 5-year TIPS over the last several years:

View more data on my Tips vs. Nominals page.

I would add the possibility of Republicans controlling both houses of Congress and the presidency, which could — ironically — tamp down GOP efforts to control the federal deficit. Having a divided Congress can help control government spending and at least force compromises on policy.

In addition, Trump would likely name a new chairman of the Federal Reserve, potentially with a much more investor-friendly policy. In his first term, Trump consistently pushed the Fed to lower interest rates, and that would likely continue.

Both Trump ($2.2 trillion stimulus package) and Biden ($1.9 trillion) deserve blame for the recent surge to a 40-year high in U.S. inflation, along with Congress for approving massive deficits and the Federal Reserve for keeping interest rates too low for too long and then failing to end bond-buying quantitative easing.

The fact is, I believe that no matter which candidate is elected, we will see higher-than-expected inflation over the next four years.

* * *

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

Comments on this article are now closed.

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, Retirement, Social Security | Tagged , , | 66 Comments

Don’t over-think the potential threat of deflation

Posted on June 23, 2024 by Tipswatch

By David Enna, Tipswatch.com

Just about every week, I get a comment or question from readers worried about the dangers of buying a Treasury Inflation-Protected Security on the secondary market with a high (or even not-so-high) inflation index.

Why is that a potential problem? Because TIPS come with a deflation-fighting guarantee: At maturity, you cannot receive less than par value, even if the nation goes through a prolonged period of deflation. Buying a TIPS with a high inflation index means part of your investment is not guaranteed to be returned at maturity.

Here is what I think: It’s possible a period of low or negative inflation could mean your TIPS investments are going to under-perform nominal Treasurys. But, under most circumstances, you are highly unlikely to lose money on that investment if held to maturity.

Some things to consider:

It has never happened. TIPS have been issued since 1997 in 5-, 10-, 20- and 30-year maturities (the 20-year was discontinued in 2009). Over that time, no TIPS has matured with an inflation index of less than 1.000, meaning par value. So the “deflation guarantee” has never been triggered for a TIPS purchased at auction.

Inflation is the norm. Since 1971, the lowest average annual inflation for any 5-year period was 1.4%, for the 5 years ending in both 2017 and 2018. For 10-year periods, the lowest was 1.6%, for the years ending in 2017. For a 30-year period, the lowest was 2.2%, for the years ending in 2020.

So if you are buying a TIPS on the secondary market with a high inflation index and 5 years remaining to maturity, you can be fairly confident you won’t be struck by a 5 year period of deflation, eating away at your original investment.

The deflation risk is more pronounced if you buy a TIPS with a very short period (meaning months) remaining to maturity. The longer the term, the lower the potential risk.

Long-term deflation is rare. The United States has not recorded a single year of December-to-December deflation in 70 years. The last deflationary year was 1954, when prices declined by 0.7%. The lowest since then was 2008, when inflation increased 0.1.%

In this chart, I have recorded 1) at the top, deflationary years going back to 1929 along with corresponding Gross Domestic Product changes in each of those years, and 2) at the bottom, the years with positive inflation but negative GDP rates.

The most devastating period of deflation came in the Great Depression years of 1930 to 1933, when prices fell a cumulative 24% from January 1930 to December 1933. That decline was matched by a similar drop in GDP.

But since 1954, inflation continued to increase even when GDP growth was negative, resulting in some classic years of stagflation in 1974, 1975 and 1980. Since the 1980s, the Federal Reserve has taken a greater role in trying to tamp down recessions, possibly easing the effects of economic downturns and holding inflation higher.

In the Great Recession years of late 2007 to mid 2009, inflation continued climbing: rising 0.1% in 2008 and 2.7% in 2009, despite negative GDP growth in 2009.

And in the brief COVID recession of 2020, inflation still managed to climb 1.4% even as the economy faltered. The next year, in 2021, annual inflation rose to 7.0%.

Short-term deflation is a risk

As I noted, the shorter the time to maturity, the more a TIPS is at risk of deflation because TIPS inflation accruals are based on non-seasonally adjusted inflation, which often dips into deflation in the later months of the year.

This chart shows month-over-month declines in non-seasonally adjusted inflation, going back to 2012. Note that minor deflation is common in nearly every November and December, and is fairly common in July, August and October. But also note that the annual inflation rate for every year is positive, overcoming the late-year swoons.

Click on image for larger version.

So if you are looking to buy a TIPS maturing in April 2025, with just a few months remaining, realize that the TIPS is likely to be hit by deflation in at least two or three of the remaining months. Its final inflation index will be set by inflation in February 2025.

The market knows what’s likely ahead for the April 2025 TIPS, and its real yield is currently higher (3.576%) than that of a similar 5-year TIPS that will mature in October 2025 (2.739%). In other words, deflation presents more of a risk for the April TIPS than it does for the October TIPS, and the market has adjusted prices to reflect that.

Is the October 2025 TIPS (with an inflation index of 1.207) safer than the April 2025 TIPS (inflation index of 1.212). Who knows? Because both are short-term investments, they both have some deflation risk. The April issue has a bit more risk and is priced accordingly. More on this here.

I Bonds have an advantage

U.S. Series I Savings Bonds pay out a composite interest rate based on a permanent fixed rate (currently 1.3%) and a six-month variable rate (currently 2.96%). No matter what happens with the variable rate, the I Bond’s composite rate can never go below 0.0% and the principal can never decline. So I Bonds have rock-solid protection against deflation.

In addition, while TIPS lose principal during spells of deflation, the I Bond never loses value. When inflation starts rising again, the TIPS has to make up lost ground. The I Bond starts increasing from where it left off, a nice advantage over TIPS.

But, on the flip side, the I Bond’s fixed rate of 1.3% (equivalent to its real yield) is well below the 2.0%+ real yields currently found on all TIPS maturities.

Worst case scenario: Japan

I can’t claim to understand anything about Japan’s complex economy, but I know that both inflation and interest rates have been very low for more than two decades in that country. This is from the World Economic Forum:

Between 1960 and the late 1980s, Japan’s economic growth was double that of the US. But in 1989, there was a stock market crash and a banking crisis in Japan. Inflation in Japan has remained low ever since, and turned into deflation in the 2000s, and again during the pandemic.

After two decades of extremely accommodative monetary policy, Japan is now moving to bring interest rates out of the ultra-low (or negative) range. Annual inflation rose to 2.8% in May 2024, considered a positive trend.

In Japan, rising inflation is considered a positive, which isn’t true in the United States. It’s hard to say if this is an omen for the U.S., or just a singular problem for Japan.

Final thoughts

If you want to build a ladder of TIPS stretching out 20 to 30 years, you are going to have to accept buying additional principal that is not protected against deflation. The TIPS maturing in February 2040 has an inflation index of 1.448, meaning the investor will be buying about 45% of additional principal. Is that actually risky? Sure, there is a very slight possibility of deflation striking across the next 16 years. But not enough to worry about, in my opinion.

If you have been holding any long-term TIPS for many years, they all have inflation accruals that aren’t protected against deflation. I could be wrong, but I don’t think the deflation risk is high enough to abandon these investments.

For example, I own CUSIP 912810FH6 in a taxable account at TreasuryDirect, a long-ago 30-year TIPS purchase that will mature April 15, 2029. It has a coupon rate of 3.875% and an inflation index of 1.90508, meaning it has accrued principal 90.5% above par value.

Do I lose sleep at night worrying about deflation eating away at my principal? No. This TIPS is a great asset. (But today, if I were looking on the secondary market for a TIPS maturing in April 2029, I would not buy this one. I’d prefer the April 2029 TIPS that just had a reopening auction with a much lower inflation index.)

Accepting some deflation risk is part of investing in TIPS. That risk, as I have noted, is fairly minor in most scenarios.

• 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

• 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.

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 I Bond, Inflation, Investing in TIPS, TreasuryDirect | Tagged , , , | 27 Comments