Investing for safety: The era of 5% yields is ending

Posted on September 22, 2024 by Tipswatch

By David Enna, Tipswatch.com

We knew this day would come, after enjoying 5% nominal yields on very safe investments for more than a year. But that era ended Wednesday when the Federal Reserve cut its federal funds rate by 50 basis points, to a range of 4.75% to 5.00%.

Today, the effective federal funds rate is 4.8%, and that means almost all safe investments already have or will soon follow the trend below 5%. Look at this chart to see how the 4-week Treasury bill — the base rate for Treasury money market funds and high-yield savings accounts — follows closely with the federal funds rate.

Click on image for larger version.

The yield on a 4-week T-bill hit a 2023 high of 6.02% on May 25, 2023, and then a 2024 high of 5.56% on May 24. Thursday, it reached the low for the year, 4.87%. And that yield will continue to decline as the Federal Reserve embarks on a course of rate cuts, probably through much of 2025.

Mr. Drysdale

For me, 5% is a magic number. When I was young, my neighborhood Savings and Loan offered a passbook savings account paying a flat 5% and that continued for years. This was the “routine” yield on savings in the 1960s. I remember an episode of the Beverly Hillbillies where banker Mr. Drysdale yelled out, “We’re holding the line on 5% interest!”

I was probably the only kid in America who laughed at that line. More proof I was, and still am, a nerd.

The trend is down

Over the last couple years, I’ve gotten a lot of feedback from readers who were choosing T-bills paying a nominal 5% over TIPS and I Bonds with inflation-protected returns. “Great choice,” I said, if your investment target is short term. But if the goal is longer term, “These rate won’t last forever.”

Here is a look at current yields of safe investment choices, both short- and longer-term. Yields across the board have already dropped below 5% or will soon get there.

A new strategy?

Instead of new strategy, maybe investors need new expectations.

“If you haven’t locked into a 5% yield yet, it’s probably too late for terms over one year,” said Ken Tumin, founder of DepositAccounts.com. “But 4%-plus mid-term and long-term CDs are still available. If interest rates keep falling, these too will soon be gone.”

Tumin advises looking for “add-on” CDs, which allow you to continue depositing money into the existing CD at its current rate.

“In addition to standard CDs at online banks and credit unions, there are a few 4%-plus add-on CDs and no-penalty CDs still available. Moving some cash into these can at least help you maintain 4%-plus yields for a few years into a low-rate cycle.”

I have been a strong proponent of investing in T-bills as part of a 2nd-level cash reserve, setting money aside to be used when needed. Back in July 2022 I suggested staggering investments in 13-week and 26-week T-bills, with some maturing every four weeks and then being rolled over. I followed my own advice and was able to ride T-bill rates from about 1.7% in 2022 to 4.87% on a T-bill I reinvested last week.

At this point, I don’t see any need to abandon this strategy. I need this cash reserve for potential spending in retirement, and I don’t want to increase risk in my portfolio. My potential returns will be smaller, but not drastically smaller for the next year, at least.

On the flip side, my core longer-term bond holding — the Vanguard Total Bond Fund ETF (BND) — has recovered nicely since the disastrous performance of 2022, when it was down 13.1%. BND had a total return of 5.66% in 2023 and is up 4.85% so far in 2024. It’s current SEC yield is 4.03%.

While short-term interest rates are almost certain to decline, there’s no certainty about longer-term rates. So there could be future opportunities to extend duration and lock in safe interest rates of nearly 4.0% — either with CDs or Treasury notes. The bond market has to settle down and adapt to the Fed’s actions.

This time around, most probably, short-term interest rates aren’t heading to zero. A more likely “neutral” level will be in the range of 3.00% to 3.50%. Annual U.S. inflation is currently running at 2.5%, and my goal as an investor would be to maintain yields above the rate of inflation. That should be possible over the next year.

Posted in Bank CDs, Cash alternatives, Inflation, Investing in TIPS, Retirement, Treasury Bills, TreasuryDirect | 38 Comments

10-year TIPS reopening auction gets a real yield of 1.592%

Posted on September 19, 2024 by Tipswatch

By David Enna, Tipswatch.com

Too often, the bond market tricks you. It happened again Thursday in the wake of Wednesday’s “sort-of surprise” action by the Federal Reserve to cut short-term interest rates by 50 basis points.

The initial (and expected) reaction after the Fed announcement was that real yields for 5- and 10-year Treasury Inflation-Protected Securities dropped by about 5 to 7 basis points. The stock market moved higher. And then … things turned around, with stock prices dipping and Treasury yields rising.

All that led into today’s $17 billion reopening auction of CUSIP 91282CLE9, creating a 9-year, 10-month TIPS. This TIPS trades on the secondary market, and at one point on Wednesday afternoon its real yield dipped to about 1.53%, before rising back to about 1.58% at the market close.

Thursday’s auction, which closed at 1 p.m. EDT, resulted in a real yield to maturity of 1.592%, which should look acceptable to investors. The “when-issued” prediction was 1.59%. The bid-to-cover ratio was a solid 2.44. By any measure, this auction went off without a hitch.

Of course, real yields have declined mightily in 2024 as the Fed began signaling its intention to cut interest rates. As recently as May 23, 2024, a similar 10-year TIPS auction generated a real yield of 2.184%, the highest since 2009. Yields have fallen 59 basis points since then.

Here is the trend in the 10-year real yield since January 2023, with today’s result falling close to the middle of the yield range:

Click on image for larger version.

For now, the days of 2.0% real yields are over, even for very long-term TIPS. The 30-year TIPS is trading today at 1.92%.

Pricing

CUSIP 91282CLE9 has a coupon rate of 1.875%, which was set by the originating auction on July 18. Because the auctioned real yield was well below the coupon rate, investors had to pay a premium price for this TIPS. The unadjusted price was 102.554561. In addition, it will carry an inflation index ratio of 1.00237 on the settlement date of September 30:

With that information, we can look at the actual investment cost of a purchase of $10,000 par value at this auction:

  • Par value: $10,000.
  • Principal purchased as of Sept. 30: $10,000 x 1.00237 = $10,023.70.
  • Cost of investment: $10,023.70 x 1.02554561 = $10,279.76.
  • + Accrued interest of about $39.33.

In summary, an investor purchasing $10,000 par at this auction paid $10,279.76 for $10,023.70 of principal and will now earn inflation accruals plus an annual coupon of 1.875% on accrued principal.

Inflation breakeven rate

With a 10-year nominal Treasury trading at 3.75% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.16%, well below recent trends. In fact, this is the lowest breakeven rate for an auction of this term since January 2021. It indicates that this TIPS will outperform a nominal 10-year Treasury if inflation averages more than 2.16% over the next 9 years, 10 months.

Here is the trend in the 10-year inflation breakeven rate since January 2023, showing the sharply downward trend since May 2024:

Click on image for a larger version.

I think it would be logical that the Fed’s dovish cut of 50 basis points would increase fears of potential inflation, since the Fed now seems to be focusing its attention on labor markets versus U.S. inflation. And the result? This rate of 2.16% is slightly higher than the breakeven at Tuesday’s market close, 2.12%.

Reaction to the auction

As I noted, this auction result looks right on target with expectations. Both the Treasury and investors can be pleased with the result. Demand was reasonably strong and the real yield was reasonably high.

CUSIP 91282CLE9 will have one more reopening auction on November 21, 2024, two weeks after 1) the U.S. presidential election on Nov. 5, and 2) another rate-cutting decision by the Federal Reserve on Nov. 6. A whole lot could change by then.

Here is the history of 9- to 10-year TIPS auctions going back to January 2021:

—————————-

• 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, TreasuryDirect | Tagged , , , , | 4 Comments

Real yields are sinking. What does this mean for Thursday’s 10-year TIPS reopening auction?

Posted on September 15, 2024 by Tipswatch

By David Enna, Tipswatch.com

First off, let’s point out that the Federal Reserve has not yet lowered interest rates by a single basis point and, in fact, the federal funds rate has been stable since July 2023.

But changes are coming this week, with the Fed likely to cut short-term rates by 25 to 50 basis points, beginning a string of rate-cutting decisions that will likely stretch well into 2025. The market has been repricing longer-term Treasurys in reaction to the potential Fed moves, and in reaction to a gradually weakening U.S. economy.

Real yields (meaning yields above inflation) hit a 2024 high on April 30, with the 10-year yield on a Treasury Inflation-Protected Security topping off at 2.28%. This is the trend since then:

In the middle of that trend, on July 18, the Treasury auctioned a new 10-year TIPS, CUSIP 91282CLE9, with a real yield to maturity of 1.883%. On Thursday this week, it will stage the first reopening auction, creating a 9-year, 10-month TIPS. The auction size is $17 billion, the highest in history for a 10-year reopening.

Obviously, a lot has changed in two months. CUSIP 91282CLE9 trades on the secondary market, and closed Friday with a real yield of 1.57%, 31 basis points below the originating auction.

Is this TIPS still attractive?

It’s definitely less attractive, we have to admit. But getting a real yield above 1.50% is at least historically appealing, or maybe at least “normal.” Here is a chart of 10-year real yields over the last 14 1/2 years:

Click on image for larger version.

I pushed this chart back to 2010 to reflect the period just before the Federal Reserve began aggressive quantitative easing in mid 2011. In April 2010 real yields peaked at 1.70% but did not again top 1.50% until November 2018. So based on “recent history” 1.50%+ looks like an attractive real yield.

I filled out my TIPS ladder in the late summer of 2023 with TIPS yielding mostly in the 1.7% to 2.2% range. A few months later, it looked like I acted too early because yields continued climbing into October. But today I can say: “I did all right.”

And that is where investors are today, but in reverse. If you are looking to add to your TIPS holdings, should you act now to lock in 1.57% in fear of falling yields, or wait in the hopes that TIPS real yields will bounce higher in the near future? Tough question.

Pricing

The July originating auction for CUSIP 91282CLE9 set its coupon rate of 1.875%, well above today’s market real yield of 1.57%. So it is currently trading at a premium price of about 102.77. In addition, it will have an inflation index of 1.00237 on the settlement date of Sept. 30. With that information, we can estimate the investment cost of $10,000 par at the current real yield of 1.57% (which will likely change by Thursday’s auction):

  • Par value: $10,000.
  • Actual principal purchased: $10,000 X 1.00237 = $10,023.70
  • Cost of investment: $10,023.70 x 1.0277 = $10,301.36
  • + Accrued interest: About $39.32.

In summary, an investor placing a order for $10,000 par at Thursday’s auction will pay about $10,301.36 for $10,023.70 in principal and from that point on will earn accruals on principal matching U.S. inflation plus a coupon rate of 1.875%.

These numbers will change before Thursday’s auction, so this is just an estimate. CUSIP 91282CLE9 trades on the secondary market and could be purchased at any time before the auction, or after, if you see a real yield you like.

Inflation breakeven rate

With the 10-year nominal Treasury note closing Friday at 3.65%, CUSIP 91282CLE9 currently has an inflation breakeven rate of 2.08%, potentially the lowest level at auction since November 2020, in the heart of the pandemic-triggered collapse in yields. A low breakeven rate indicates that a TIPS is “cheap” versus a nominal Treasury of the same term.

Here is the trend in the 10-year inflation breakeven rate over the last 14 1/2 years, which shows the recent decline from levels nearing 3.0% in April 2022 and then 2.4% in April 2024:

Click on image for larger version.

Do you think inflation will average more than 2.08% over the next 10 years? If so, this TIPS is attractive versus a nominal 10-year Treasury.

I Bond alternative

As real yields decline, the current U.S. Series I Savings Bond — with a fixed rate of 1.3% above inflation — is looking attractive. At Friday’s close, a 5-year TIPS had a real yield of 1.48%, only an 18-basis-point advantage over the I Bond. That is an extremely low spread. At the last rate reset, on May 1, the spread was 95 basis points.

I Bonds with a fixed rate of 1.3% are going to get more and more attractive if TIPS real yields continue to decline through October. The fixed rate, which is permanent, could decline for I Bonds issued after November 1, but it’s too early to make that call.

Final thoughts

There is no particular reason to buy this TIPS at auction instead of on the secondary market, unless you want to use TreasuryDirect (where the minimum purchase is just $100). You can check Bloomberg’s Current Yields page to track the yield of CUSIP 91282CLE9 in real time.

If the real yield was still in the 1.75% range, I’d be tempted to make a purchase. But I have filled the 2034 rung of my TIPS ladder (real yields of 1.81%, 1.89% and 2.04%) and I am awaiting the Jan. 23, 2025, auction of a new 10-year TIPS to mature in January 2035. Real yields seem likely to be lower by then, but I am going to wait it out.

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 results after the auction’s close. Meanwhile, here is a history of recent 9- to 10-year TIPS auctions. Notice that less than three years ago the auctioned real yield was -1.145%, the lowest in history for this term:

—————————-

• 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, I Bond, Inflation, Investing in TIPS, Savings Bond, TreasuryDirect | Tagged , , , | 9 Comments

U.S. annual inflation in August fell to 2.5%, lowest since February 2021

Posted on September 11, 2024 by Tipswatch

By David Enna, Tipswatch.com

U.S. annual inflation continued on a downward trend in August, falling from 2.9% in July to 2.5%, the lowest annual rate in 3 1/2 years.

For the month, seasonally-adjusted inflation rose 0.2%, the Bureau of Labor Statistics reported, which matched expectations. But the annual number was below expectations of 2.6%. Core inflation, which removes food and energy, rose 0.3% for the month (slightly higher than expectations) and held steady at 3.2% for the year.

Once again, shelter costs were the trouble-maker in this inflation report. The index for shelter rose 0.5% in August and was up 5.2% year-over-year. The BLS called shelter “the main factor” in the increase in all-items inflation. Also in the report:

  • Gasoline prices fell 0.6% for the month and are down 10.3% year-over-year.
  • The costs of food at home increased just 0.1% and are up 2.1% for the year.
  • Apparel costs rose 0.3% and were also up 0.3% for the year.
  • The costs of medical care services fell 0.1% for the month but are up 3.2% for the year.
  • Costs of used cars and trucks fell 1.0% (the third monthly decline in a row) and are down 10.4% for the year.
  • Costs of new vehicles held steady and are down 1.2% for the year.
  • Motor vehicle insurance costs increased 0.6% for the month and are up a lofty 16.5% over the last year.
  • Airline fares rose 3.9% for the month, after declining five months in a row.

So this report, overall, shows a positive trend of declining U.S. inflation, with the annual rate dropping to its lowest level since February 2021. Inflation watchers know that 2.5% for CPI-U is entering a normal historical range. Here is the trend in U.S. inflation over the last 12 months, showing the sharp decline in all-items inflation, despite lingering high costs of shelter:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I 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 August, the BLS set the CPI-U inflation index at 314.796, an increase of 0.08% over the July number.

For TIPS. Today’s report means that principal balances for all TIPS will increase 0.08% in October, after rising 0.12% in September. Here are the new October Inflation Indexes for all TIPS.

For I Bonds. The August inflation report is the fifth of a six-month string that will determine the I Bond’s new variable rate, which will be reset on November 1 and eventually roll into effect for all I Bonds. After five months, inflation has increased 0.79%, which would translate to a variable rate of 1.58%, down from the current 2.96%.

View historical data on my Inflation and I Bonds page.

One month remains, so we could be looking at a variable rate in the range of 1.78% to 1.98%, which would disappoint I Bond investors. But that’s the trend in inflation over the last half year. And September’s rate is not likely to bump higher, given the current trend in gasoline prices:

I Bonds, in my opinion, remain attractive with the current fixed rate of 1.3%, which remains in place for the potential 30 years to maturity. But older I Bonds with fixed rates of 0.0% to 0.2% are likely to deliver weak returns for six months.

What this means for Social Security COLA

The Social Security Administration uses a different inflation index — CPI-W — to determine the next year’s cost-of-living-adjustment. And it looks only at the average of three months of data, from July to September, compared with the average for the same three months of the previous year. For August 2024, the BLS set the CPI-W index at 308.640, an increase of 2.4% over the last year.

Here is the current trend, with a COLA of 2.4% looking increasingly likely:

My earlier projection of 2.7% is not looking good.

What this means for future interest rates

The August inflation report is good news for the Federal Reserve, even though shelter costs remain a nagging sore point and monthly core inflation was a tick higher than expectations. Annual CPI-U has fallen to 2.5%, and the Fed’s preferred index, Personal Consumption Expenditures, is also trending lower.

The Fed’s Open Market Committee will meet next week and we can be nearly 100% certain that meeting will result in a cut in short-term interest rates. I would guess 25 basis points, because I believe the Fed will want to act cautiously. There is little evidence that the U.S. economy, while slowing, is heading toward a steep decline.

This morning’s Wall Street Journal report includes the subhead: “CPI data tees up Fed to begin gradually cutting rates next week.” That’s on target.

• 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

—————————-

• 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 or the display breaks on the mobile site. 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, I Bond, Inflation, Investing in TIPS, Retirement, Savings Bond, Social Security | Tagged , , , | 23 Comments

Looking back at my longest-held stocks

Posted on September 9, 2024 by Tipswatch

By David Enna, Tipswatch.com

After writing my memorial to financial guru Bob Brinker last week, I thought it would be interesting to look back at my individual stock investments over the years, or at least the ones I am still holding.

Back in 1999, I will admit to being caught up in the stock-trading mania of the time, purchasing stocks like Oracle, AT&T Corp., Broadcom, 3M, Waste Management, Gillette, Phillip Morris, Eli Lilly, etc., etc. I no longer hold any of those stocks. I made profits on some, lost money on some. Trading that often was a bad idea.

After the year 2000, and especially after I retired in 2016, I started to concentrate my holdings in low-cost, quality index ETFs, such as Vanguard Total Stock Market (VTI), Vanguard Total International (VXUS), Vanguard Dividend Appreciation (VIG) and Vanguard Small-Cap Value (VBR). When stocks I held went down enough to minimize capital gains, I sold them and reallocated to these funds.

So today my wife and I own very few individual stocks. Most of the remaining holdings have high capital gains and would best be donated to charity or simply held to … whenever. But how well have these stocks actually performed? That was the question I wanted to answer.

This chart shows every individual stock we currently own, with one exception. The only new holding is Element Solutions Inc. (ESI) which I bought (for some reason) in July 2024. Right now it is down slightly from the purchase price.

The key thing to note here is that the Vanguard Total Stock Market ETF has had an annual total return of 13.63% over the last 15 years, which is better than every one of my longer-term holdings other than Lowe’s Corp., which has returned 18.36%.

On the other hand, my two shorter-term holdings, NVDA and UNH, have done better than the total stock market’s return of 13.72% over the last 5 years.

Why Nvidia?

I am a big fan of computer video games (mostly ones involving dragons) and back in late 2018 Nvidia was producing the highest-quality graphic processing units (GPUs) for gaming. Its stock was tumbling at the time so I bought some. I didn’t pay much attention to the stock until …. 1) the cryptocurrency craze of 2020, when Nvidia chips were highly coveted for crypto mining, and then 2) this year’s artificial intelligence craze, which we are still enduring.

So today the stock is up a ridiculous 3,100%, despite declining sharply in recent weeks. In the past couple years I have sold off about 4 times my original investment, so I am comfortable just holding. NVDA is not my typical investment. There is only one thing to say: I got lucky. Thank the dragons.

The bigger lesson

The stocks I currently own are my “winners” with large capital gains and therefore not attractive to sell. Across the years, there have been plenty of losers and mediocre holdings I’ve sold and then moved proceeds into index funds.

The easy conclusion is that I would have been much better off investing in the total stock market instead of making bets on individual stocks, even with the happy accident of buying Nvidia at just the right time.

Bob Brinker would agree.

* * *

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 or the display breaks on the mobile site. 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 Investing in TIPS | Tagged , , , , | 13 Comments