Treasury Inflation-Protected Securities

10-year TIPS reopening auction could reach real yield of 2.0%

Posted on March 17, 2024 by Tipswatch

By David Enna, Tipswatch.com

The U.S. Treasury on Thursday will offer $16 billion in a reopening auction of CUSIP 91282CJY8, creating a 9-year, 10-month Treasury Inflation-Protected Security.

Real yields have been trending higher over the last few weeks, with the 10-year up about 12 basis points since March 1. And so it looks possible that this reopening will generate a real yield to maturity of 2.0%+ for only the third time since January 2009, a total of 87 auctions of this 9- to 10-year term.

I consider the 10-year to be the most desirable of TIPS offerings because of its medium term and generally higher yield versus the 5-year. Plus, a real yield of 2.0% over 10 years is an excellent investment target.

CUSIP 91282CJY8 is the only TIPS maturing in 2034, although another new 10-year will be auctioned in July. The offering size of $16 billion is the largest ever in history for a 10-year TIPS reopening auction. Three years ago, the March 2021 reopening size was $13 billion.

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.

CUSIP 91282CJY8 has a coupon rate of 1.75%, which was set at the originating auction on Jan. 18. It trades on the secondary market, and you can check its yield and price in real time on Bloomberg’s Current Yields page:

At Friday’s close, CUSIP 91282CJY8 was trading with a real yield of 1.99% and a discounted price of 97.89, which reflects the below-market coupon rate of 1.75%. Because real yields have been climbing recently, it’s possible we could see 2.0% at Thursday’s auction. However, as one of my readers noted this week, 1.98% is close enough if you are purchasing on the secondary market.

Here is a look at the 10-year real yield over the last 20 years, providing perspective on the rarity of a 2.0% real yield over the last two decades, an era of aggressive Federal Reserve manipulation of the Treasury market:

Real yields could go higher, definitely, but are attractive in this current range.

Pricing

Let’s look at a hypothetical purchase of $10,000 par of this TIPS at Thursday’s auction, assuming a real yield to maturity of 1.99% and a price of 97.89. (Things will change, but this will give us an idea.) CUSIP 91282CJY8 will have an inflation index of 1.00264 on the settlement date of March 28.

Par value: $10,000
Principal purchased: $10,000 x 1.00264 = $10,026.40
Cost of investment: $10,026.40 x 0.9789 = $9,814.84
+ Accrued interest = About $35.

In summary, an investor would be paying $9,814.84 for $10,026.40 of principal and then would collect inflation accruals for the next 9 years, 10 months, plus an annual coupon rate of 1.75%.

Inflation breakeven rate

The 10-year nominal Treasury note closed Friday with a yield of 4.31%, which creates an inflation breakeven rate of 2.32% for CUSIP 91282CJY8, as of Friday’s close. That is slightly below the 2.34% generated by the originating auction in January. Over the last 10 years, ending in February, inflation has averaged 2.8%.

At this stage in the U.S. economy, with inflation reviving over the last two years, 2.32% seems like a reasonable breakeven rate. Here is the trend in the 10-year breakeven over the last 20 years, showing that 2.32% is a bit high historically, but within typical ranges in times of Federal Reserve inaction.

Final thoughts

CUSIP 91282CJY8 looks attractive right now, and there is no particular reason to wait until Thursday’s auction to purchase it. Investors comfortable with buying on the secondary market could pull the trigger at any time, before or after the auction, and know exactly what the real yield will be. Investors buying at the auction on Thursday won’t know the real yield until the auction closes at 1 p.m. EDT. It could be higher or lower than expected.

Either way, if you are intent on building a TIPS ladder out to 2034 and beyond, CUSIP 91282CJY8 would make an attractive addition. Again, I emphasize that real yields could continue rising, or begin falling later this year. We don’t know.

I won’t be a buyer because I already purchased CUSIP 91282CJY8 at the originating auction (real yield of 1.81%) and then later on the secondary market (1.89%). So my 2034 needs are met at this point.

This TIPS auction closes Thursday at 1 p.m. EDT. 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.

You can track yields in real time on Bloomberg’s Current Yields page. This provides a fairly accurate estimate for the auction result, but the results often skew a bit higher or lower. I hope to post the results soon after the auction closes on Thursday.

Here’s a history of 9- to 10-year TIPS auctions over recent years. I like to point out that just two years ago, this same March reopening auction generated a real yield of -0.589%. That was a lousy time to buy a TIPS. Things have improved.

• 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

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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, TreasuryDirect | 30 Comments

February inflation again slides higher than expectations

Posted on March 12, 2024 by Tipswatch

Markets react with a shrug, but what does it mean for the Federal Reserve?

By David Enna, Tipswatch.com

February’s inflation report, just released by the Bureau of Labor Statistics, provides further support to the Federal Reserve’s caution on launching into interest-rate cuts.

Once again, U.S. inflation ran a bit higher than expected, with all-items seasonally-adjusted prices rising 0.4% for the month and 3.2% year over year. Annual inflation actually ticked higher versus January’s 3.1%.

Core inflation, which removes food and energy, came in at 0.4% for the month and 3.8% year over year. Both of those numbers were higher than economist expectations. So the trend of stubbornly high core inflation continues.

One important factor in the all-items increase was the return of higher gasoline prices, which rose 3.8% in February, after falling for four consecutive months. But gas prices remain 3.9% lower over the last year. The BLS also pointed to the shelter index as a key contributor, rising 0.4% for the month and 5.7% year over year.

Food prices, however, reflected good news: The food-at-home index was unchanged from January and up only 0.1% year over year. Other news from the report:

The index for dairy and related products decreased 0.6% in February, led by a 1.1% decline in the index for cheese and related products.
The index for rent rose 0.5% over the month and 5.8% for the year.
Costs of new vehicles fell 0.1% for the month and were up only 0.4% year over year.
Prices for used cars and trucks rose 0.5% after falling 3.4% in January.
Apparel prices rose 0.6% after falling 0.7% in January.
Airline fares rose 3.6% in February, but are down 6.1% year over year.
Costs of motor vehicle insurance rose 0.9% for the month and are up a mighty 20.6% over the last year.

Here is the 12-month trend in annual all-items and core inflation, showing that the battle against U.S. inflation has made little progress over the last seven months:

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 February, the BLS set the inflation index at 310.326, an increase of 0.62% over the January number.

For TIPS. The February inflation index means that principal balances for all TIPS will increase 0.62% in April, after rising 0.54% in January. While these might seem like outsized numbers, this result follows the typical trend at the beginning of each year, when non-seasonally adjusted numbers run higher than the “official” adjusted indexes. Here are the new April Index Ratios for all TIPS.

For I Bonds. The February inflation report is the fifth of a six-month string that will determine the I Bond’s new inflation-adjusted variable rate, to be reset May 1 and eventually roll into effect for all I Bonds. As of February, with one month to go, inflation has increased 0.82% over the five months. That would translate to a variable rate of 1.64%, much lower than the current variable rate of 3.94%.

One month remains, and it is likely we could see non-seasonal inflation in the range of 0.4% to 0.6% for March. That would boost the variable rate to somewhere in the range of 2.4% to 2.8%.

The new variable rate will be set in stone by the March inflation report, which will be issued at 8:30 a.m. EDT on April 10. Here are the data so far:

View historical data on my Inflation and I Bonds page.

What this means for future interest rates

The February inflation report did come in higher than expectations, but it wasn’t a severe miss. At 9:20 a.m. both the S&P 500 and NASDAQ indexes were higher in pre-market trading, so investors seemed to be reacting with a shrug.

But the Wall Street Journal report this morning notes that February inflation brings “greater uncertainty over when the Federal Reserve will lower interest rates.”

“A rate cut at the Fed policymakers’ meeting next week still looks to be off the table, with interest-rate futures implying that investors see next to no chance of one,” the Journal reported.

No one was truly expecting the Fed to cut interest rates this month. That decision is probably coming in May or June at the earliest, so the Fed will have more data to ponder in coming months.

From Bloomberg Economics’ Anna Wong:

The hot core CPI reading won’t build Fed confidence to cut rates imminently — but it also doesn’t rule out the chance of a mid-year rate cut. We still expect the Fed to gain enough confidence to cut rates as soon as May — our base case — as both inflation and the labor market cool further

Other economists interviewed by Bloomberg saw the first rate cut coming no earlier than June. Of course, no one can accurately predict future inflation or Fed actions. One final thought from Brian Coulton, chief economist at Fitch Ratings:

This is a sober reminder of the tendency for inflation to perpetuate itself. That is not the direction the Fed wants to see.

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Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS | Tagged economy, Federal Reserve, finance, inflation, news | 26 Comments

Attention investors: Is it time to rebalance?

Posted on March 10, 2024 by Tipswatch

By David Enna, Tipswatch.com

While returning home from New Zealand a few days ago, I got into an airport conversation with a traveling friend. I mentioned I had a lot of things to do once I got home (about 30 hours later):

“Taxes. Yeah, we have to finish filing our income taxes … plus, we really need to look at rebalancing our portfolio, with stocks at an all-time high,” I said.

My friend, a retired long-time financial adviser, got a shocked look on her face. “Oh, rebalancing! I always advised my clients to do it, but we haven’t done a thing since 2016. We just don’t get around to it.”

As it turns out, that financial adviser’s faux pas was probably a very good thing. Over the last 10 years, the S&P 500 has had an annualized total return of 12.5%, a spectacular performance. Letting your stock allocation ride higher created a lot of wealth.

But my wife and I are conservative investors, so we hold to a plan to maintain a conservative asset allocation by rebalancing our portfolio, when needed, to line up with these goals:

23.3% in U.S. stocks (primarily in low-cost total U.S. stock funds)
11.7% in international stocks (similar low-cost index funds)
61.5% in bonds/fixed income (includes low-cost index funds + TIPS, I Bonds, CDs, nominal Treasurys)
3.5% in cash.

This allocation — 35% in stocks and 65% in fixed income/cash — is probably way too conservative for most investors. But this is a reflection of where we are in life. Asset allocation is a very personal thing.

Back in 2018, my wife and I went through a financial planning exercise with Allan Roth, a well-known adviser and author. When I saw that he titled his website “Dare to Be Dull,” I knew we found the right guy. Roth charges by the hour for a one-time, long-term focused plan and then recommends, “fire me.”

During our discussions, I suggested the 35%/65% asset mix and to my surprise, Roth agreed. Why? Because that was our comfort level. Plus, it would work for our needs.

Early on, I offered that we would probably be willing to raise the stock allocation to 40% if he thought that would be better. Roth responded, “OK, if you want to raise your stock allocation, I want you to wait until the stock market declines 20% and then do it.” Hmmm … OK.

As it turns out, I have heard Roth mention this advice many times since then, noting that no client has ever done it in the heat of a bear market. The man is clever. Our asset allocation was fine, and will continue to be fine.

If you want to get Roth’s advice at a very low cost, I suggest buying his book: “How a Second Grader Beats Wall Street.” His writing style is brisk and easy to understand, and he drives home the philosophy of low-cost index investing and simple portfolio structure. I also advise subscribing to his newsletter, which links to his many articles for AARP.com, ETF.com and AdvisorPerspectives.com.

In his book, Roth calls rebalancing “market timing that actually works.”

When you stop and think about it, rebalancing is a systematic way of buying low and selling high. … It forces us out of the ranks of the faux contrarian into the less-traveled ranks of the true contrarian. … Rebalancing forces us to sell some of what’s hot and buy some of what’s not.

Asset rebalancing and asset location are key principals of Roth’s philosophy. By “asset location” I mean optimizing the assets in each of your accounts. For example:

Taxable brokerage, bank accounts: Ideal for stock holdings because of favorable tax rates on capital gains and dividends. Plus, spendable cash.
Traditional tax-deferred accounts: Ideal for bond funds, REITS, nominal Treasurys, TIPS, etc., plus any actively managed fund that could generate high capital gains or dividends. Also the place to hold assets you plan to donate to charity. These holdings will eventually be subject to required minimum distributions.
Roth accounts: Ideal for stock funds, with the assumption that these will be your longest-held assets. These assets will never be taxed, even if inherited.
I Bonds: A separate category, since interest is tax-deferred but not subject to RMDs. I classify my I Bond holdings as “bonds,” but they have some qualities of cash, since they are protected from loss and redemption is flexible.

By following Roth’s guidelines, we were able to simply our portfolio — one of his key principals. The number of holdings and accounts is much smaller. I can calculate our asset allocation accurately within one hour. How often should this be done? I can’t give a definitive answer, but we do the calculation about three times a year. Sometimes we take actions, many times we don’t.

Here is the history of our rebalancing decisions over the last 4 1/2 years:

A key thing to keep in mind is that you don’t need to hit the percentage marks exactly — being off a few percentage points is fine. The point is to be aware of how market trends are setting your asset allocation adrift. And the rebalancing can be in small moves. For example, when you need to raise cash in retirement, an updated asset allocation can guide your decision. (Truth is, we generally do rebalancing in gradual moves.)

Note that in December 2019 we were close to our asset allocation and no action needed to be taken. But by March 2020 — in the midst of the pandemic-induced market panic — we needed to sell bonds and buy stocks. We did. Since then, the stock market has been on a run higher, so we have sold stocks at times and 1) bought bond funds in tax-deferred accounts, or 2) withdrew money to raise our cash levels, or 3) converted from traditional to Roth accounts.

Both the stock and bond markets took a hit in 2022, which left our asset allocation intact. No action was needed. In more recent times, as the stock market has been rising, we have again lowered our stock holdings and bought bonds — which finally look more attractive.

Not for every investor

If you haven’t rebalanced in recent years, and you hold a large stock allocation, your investments have done a lot better than mine. Congratulations! You just have to realize that your holdings have gotten a bit more risky over time. If your investing timeline is long, that is probably OK.

A lot of investors and financial advisors discourage rebalancing, and in fact that includes the guiding light of investing, Jack Bogle. He said this in an 2013 interview with Morningstar’s Christine Benz:

I am in a small minority on the idea of rebalancing. I don’t think you need to do it. The data bear me out, because the higher-yielding asset is going to be stocks over the long term. That’s the way the capital markets work. …

There is a comfort level for an investor. …. Anybody that feels they should rebalance, I think they should rebalance. I wouldn’t tell them not to. But I’d say, do it in a little more sensible way than it’s done.

I wouldn’t have some formula: oh my God, I’ve gone from 60% to 61%. I better get back to 60%. On a given day, that may happen in these markets. So it should be some range. Say you want to stay close to 65%. If you get below 60%, you can rebalance. If you get above 70%, you rebalance. And you try and not do it not with any great frequency.

A contrary view comes in this video from the Money Guys, Brian Preston and Bo Hanson, who have a popular YouTube channel dispensing solid, no-nonsense advice. They call rebalancing “a skill set that will serve you over the long term,” especially during the draw-down years of retirement:

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Posted in Cash alternatives, I Bond, Retirement, Taxes | Tagged investing, personal-finance | 57 Comments

Let’s check in on the I Bond’s next fixed rate

Posted on February 26, 2024 by Tipswatch

By David Enna, Tipswatch.com

Earlier this year, I think most I Bond investors were assuming that the I Bond’s next fixed rate would end up being lower than the current 1.30%, the highest fixed rate since November 2006. But things have changed.

I did a quick analysis of average real yields for 5- and 10-year TIPS from Nov. 1, 2023 — just after the last rate reset — to Friday’s close. After years of trying prediction formulas, I have settled on “average daily real yield” over the entire six-month rate-setting period as the best predictor of the Treasury’s future decision. But of course, it is not perfect.

My findings: At this point, I would guess the Treasury will hold the I Bond’s fixed rate at 1.30% at the May 1 reset, based on a ratio of 0.65 applied to the average daily real yield, with the result rounded to the 1/10th decimal point.

On Oct. 27, 2023, I posted a prediction on the I Bond’s Nov. 1 reset, showing that the 10-year real yield had averaged 1.78% from May to Oct. 26, 2023. If you applied a ratio of 0.65 to that number, you got a fixed rate projection of 1.20%. The Treasury decided on 1.30%.

In that projection, I ignored the 5-year average real yield, which was substantially higher at 1.99% from May to October 2023. Applying the 0.65 ratio to 1.99% gets you to 1.29%, which rounds to a 1.30 fixed rate. So it is clear that the 5-year real yield also matters.

Qualifications

More than two months remain before the Treasury’s fixed-rate decision, so things are likely to change, either up or down. It’s too early to say, but right now it does look like the I Bond’s fixed rate could hold steady at 1.3%, or even go higher if real yields continue climbing.

Want to do this calculation?

The process is simple, using the Treasury’s Real Yield Curves page. For the November 2023 to current day period, you will need to download two .csv files from the site. This .csv file is a simple spreadsheet you can open with Excel.

First, use the selection box to select 2023 and click Apply. You will see a list of all real yields for the entire year. You will also see “Download CSV” as a link. Click on that and you will immediately download a .csv file with all real yield data for 2023. This link should work.
Next, do the same thing to get to the 2024 listing and download that .csv file. This link should work for that.
Find the files in your download folder, or wherever you saved them.
Open the files and in the 2023 version, eliminate all data before Nov. 1. You can also delete the columns for 7-, 20- and 30-year TIPS, if you like. Then open the 2024 file and copy the date column, along with the 5- and 10-year real yield columns.
Paste the 2024 data onto the end of the 2023 data and you now have a list of all 5- and 10-year real yields for the current period.
Use Excel’s “sum” function to add each column. Then divide the results by the number of rows with data and you have your average daily real yield.
Multiply each average real yield by 0.65 to get an estimate of the potential I Bond fixed rate, at that point in time. Reminder: This is only an estimate.

What this means

At this point, it still looks like the I Bond’s next variable rate could come in around 2.0%, lower than the current 3.39%. If that is true, and it looks like the I Bond’s fixed rate will hold at 1.3%, then investing in April would make sense, to lock in the current composite rate of 5.27% for a full six months.

But again, things can change. I’d continue advising holding off on I Bond investments until April 10, when the March inflation report is released and the I Bond’s new variable rate will be set. If it is going to be higher than the current 3.94%, then investing in May might be the best choice.

I’ll be updating this I Bond fixed rate projection in mid-April with more complete numbers.

• I Bond buying guide for 2024: Be patient

• 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

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Posted in Cash alternatives, I Bond, Inflation, TreasuryDirect | 15 Comments

30-year TIPS auction gets real yield of 2.20%, highest in 14 years

Posted on February 22, 2024 by Tipswatch

By David Enna, Tipswatch.com

The Treasury’s auction of a new 30-year Treasury Inflation-Protected Security — CUSIP 912810TY4 — generated a real yield to maturity of 2.20%, the highest for this term at auction since February 2010. The coupon rate for this TIPS was set at 2.125%, matching a 14-year high.

I consider this a solid result. Just before the auction close, a similar TIPS was trading on the secondary market with a real yield of 2.19%, so the auction result was very close to market. The bid-to-cover ratio was a solid 2.48.

When looking at this result in historical terms, it is worth noting that the Treasury stopped issuing 30-year TIPS from October 2001 to February 2010. So today’s result matches the highest yield and coupon rate in the era since February 2010.

Pricing

Because the coupon rate was set slightly lower than the auctioned real yield to maturity, investors got this TIPS at a slight discount, with an unadjusted price of 98.359923. In addition, the TIPS will have an index ratio of 0.99952 on the settlement date of February 29. So this is how a $10,000 investment in this TIPS would be priced:

Par value: $10,0000
Adjusted principal ($10,000 x 0.99952) = $9995.20
Cost of investment ($9,995.20 x 0.98359923) = $9,831.27
+ Accrued interest = $8.17

This is a pretty simple auction result to understand. The investor got $10,000 in par value, but paid $9,831.27 for $9,995.20 in principal as of Feb. 29. The accrued interest will be returned at the first coupon payment on August 15.

Inflation breakeven rate

With the nominal 30-year Treasury bond trading at 4.47% just before the auction result, this TIPS gets an inflation breakeven rate of 2.27%, which looks fine. This means the TIPS will outperform the nominal Treasury if inflation averages more than 2.27% over the next 30 years.

Here is a history of recent TIPS auctions of this term: