Looking to invest in longer-term TIPS? There’s a problem.

Posted on May 25, 2023 by Tipswatch

By David Enna, Tipswatch.com

I recently got an email with a question from long-time site reader Jay, who included a meme to illustrate his point. Here it is:

A TIPS Conundrum:

Lately I’ve been struggling with what to do in my bond portfolio. Should I take advantage of current high real TIPS yields to lock in high returns with LT TIPS? However, doing so goes against my long held desire to avoid taking interest rate risk on long duration bonds, especially with rates jumping around. 

Which to do? Locking in high real TIPS yields for 10-20 years might be a unique opportunity. OTOH, buying LT bonds of any kind in a volatile market is very risky. 

I don’t know the answer, but I came up with this Meme to describe it.

My thoughts

I understand. I also have been looking to load up on longer-term Treasury Inflation-Protected Securities (with maturities beyond 10 years). I see the logic in locking in attractive real yields for a longer term. But that’s a difficult task for four reasons:

  1. I am nearing age 70 so my hold-to-maturity range is optimistically no more than 21 years, stretching out to potentially 2044.
  2. There is a yawning gap in TIPS available on the secondary market, with no TIPS maturing in the years 2034 to 2039.
  3. TIPS maturing in years 2040 and 2041 have a combination of a high coupon rate and a high inflation index, making them pricey investments versus par value.
  4. TIPS maturing in years 2042 to 2045 have lower coupon rates and therefore sell at a discount to par, but also have inflation factors of 28% or higher. These are more attractive, but still pricey versus par value.

Why the gap?

20-year TIPS. From July 2004 to January 2009, the Treasury issued 20-year TIPS, resulting in just five securities of that term. Then Treasury discontinued the 20-year TIPS and it has never returned. That means there are no 20-year TIPS maturing beyond the year 2029.

30-year TIPS. The Treasury offered 30-year TIPS from 1998 to 2001, and then discontinued this maturity until it was restarted in 2010. So that means there are no 30-year TIPS maturing from April 2032 to February 2040.

So we have a gap, with no TIPS available to purchase with maturities from 2034 to 2039. In a real-life portfolio, what does this mean? Here is my TIPS ladder, updated through May 2023, with all par values set to $1,000 to present as an example:

This chart shows the coupon rate, not the actual real yield to maturity at the time of investment.

The key here is that I have no TIPS maturing in the years 2034 to 2040. There are no TIPS available for years 2034 to 2039, and I don’t find the TIPS available in years 2040 and 2042 attractive enough to purchase.

In the last year, I’ve developed a habit of looking at the secondary market for TIPS maturing in my gap years. That worked out well for me in November 2022, when I grabbed CUSIP 912810RA8 — maturing in February 2043 — with a real yield to maturity of 2.02% and a total investment price below par value.

That was a lucky hit, just as TIPS real yields were peaking. I haven’t been able to find anything nearly as attractive in recent months. Here is a look at secondary market prices as of Wednesday for my gap-year TIPS:

The first two on this list, which work “better” in my life-expectancy timeline, both have higher-than-market coupon rates and high inflation factors, making their pricing at least 7.5% above purchased principal. I don’t like buying above-par principal at prices well above value. So these are out.

The last four in the list would work better for me, with coupon rates below market real yields and therefore selling at a discount. Note that CUSIP 912810RA8 — which I bought last November — now carries a real yield to maturity of about 1.7%, down from 2.02% at the time of my purchase. Plus its inflation index has now increased about 1.8%.

Of these issues, I’d be most interested in CUSIP 912810QV3, which matures in February 2042 and would fill that spot on my TIPS ladder. I’d just like to see the real yield rise a bit higher.

• May 28 follow-up: I pulled the trigger on the February 2042 TIPS

My personal opinion, and you can disagree: I am OK with buying inflation-accrued principal (meaning above par value) if I can get it at a discount price. That is true for all four of the the TIPS maturing from 2042 to 2045.

When you pay a price above par value for a TIPS — which is often the case on the secondary market — you take a tiny risk because the amount above par is not guaranteed to be returned at maturity if we hit a long stretch of deflation. That is a risk I am willing to take.

What about a TIPS fund?

Another option for investors would be to look at an ETF that invests in longer-term TIPS. One option is the PIMCO 15+ Year US TIPS Index ETF (LTPZ), with an expense ratio of 0.2%. Because of its long duration (19.8 years) this fund is volatile. If real yields rise in the future, its performance would be disastrous. If they fall, it will do very well. Here are its total annual returns, from Morningstar:

This fund’s total annual return over the last five years is 1.43% and for 10 years, 1.33%. Because of its volatility, LTPZ doesn’t fit my investment style or meet my need for stability in a TIPS investment ladder. My vote is “no.”

The only TIPS fund I currently own is Vanguard’s Short-Term Inflation-Protected ETF (VTIP) with an expense ratio of 0.04% and a duration of only 2.6 years. I use this fund in a traditional IRA to hold money awaiting investment in individual TIPS. It’s not very volatile and also not very exciting, which fits my needs:

VTIP’s total annual return over the last five years was 2.81% and for 10 years, 1.53%. Both of these returns beat LTPZ’s performance, with much less risk. But while I like VTIP, it doesn’t fill my need for more exposure to longer-term TIPS.

I Bonds can fill the gap

If you purchase an I Bond today with a fixed rate of 0.9%, you get a flexible investment that you can hold for any time period, from 1 to 30 years. So I Bonds can work well to fill that TIPS gap for the years 2034 to 2039, and beyond. I Bonds don’t sell at a premium and can never lose a cent of value, even if deflation sets in or interest rates rise. For that reason, I think I Bonds are much more attractive than a long-term TIPS fund like LTPZ.

• 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 I Bond, Investing in TIPS, Retirement | 40 Comments

10-year TIPS reopening auction gets a real yield of 1.395%, 2nd highest in 12 years

Posted on May 18, 2023 by Tipswatch

By David Enna, Tipswatch.com

The Treasury’s auction today of CUSIP 91282CGK1 — a 9-year, 8-month Treasury Inflation Protected Security — generated a real yield to maturity of 1.395%, a good result for investors but just slightly below market trends.

Earlier in the day, this TIPS was trading on the secondary market with a real yield to maturity of 1.41%, so the auction result came in slightly lower. Pretty close. The bid-to-cover ratio was a middle-of-the-road 2.31, indicating acceptable but not stellar demand.

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.

On the positive side, the real yield of 1.395% was the 2nd highest for any TIPS auction of this 9- to 10-year term dating back to a reopening auction in April 2010. The only auction with a higher result came in November 2022 at 1.485%.

Here is the trend in the 10-year real yield over the last 12 months, a remarkable period when we have seen real yields rise from 0.0% to today’s 1.395%:

Click on image for a larger version.

Pricing

CUSIP 91282CGK1 has a coupon rate of 1.125%, which was set by the originating auction on January 19. Because the auctioned real yield was higher, this TIPS sold at a discount, with an unadjusted price of 97.575406. It will have an inflation index of 1.01319 on the settlement date of May 31.

Here is how the pricing works out for today’s investors:

Note that the cost of investment came in lower than the par value, even with the addition of the 1.01319 inflation index. This is because of the 27-basis-point spread between the real yield and coupon rate, which was large enough to cover the inflation accrual. It’s not a big deal, but remember that with any TIPS par value is guaranteed to be returned at maturity, even after a long period of deflation.

Inflation breakeven rate

With a 10-year nominal Treasury note trading at 3.64% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.25%, close to recent results for this term. It means that CUSIP 91282CGK1 will outperform a nominal 10-year Treasury if inflation averages more than 2.25% for the next 9 years, 8 months.

Here is the trend in the 10-year inflation breakeven rate over the last year, demonstrating that inflation expectations have been sliding lower as the Fed has raised interest rates and continued quantitative tightening:

Final thoughts

This auction was a good result for investors. Earlier in the morning, it looked like the real yield could end up around 1.41%, but this result was fine — the second highest auctioned real yield in a dozen years. I was a buyer. I’m happy.

It’s impossible to say where real yields will be heading, even in the near-term future. They could certainly go higher, but I think this period of fairly stable high real yields is a good time to continue adding to your hold-to-maturity TIPS investments.

This auction closes the books on CUSIP 91282CGK1. A new 10-year TIPS will be auctioned on July 20 and then reopened in September and November.

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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 Inflation, Investing in TIPS | 15 Comments

Thursday’s 10-year TIPS reopening auction looks attractive; ignore the Treasury turmoil

Posted on May 16, 2023 by Tipswatch

By David Enna, Tipswatch.com

The U.S. Treasury on Thursday will auction $15 billion in a reopening of CUSIP 91282CGK1, creating a 9-year, 8-month Treasury Inflation-Protected Security.

Although the Treasury market is filled with uncertainty this month as a debt-limit disaster looms ahead, this TIPS remains an attractive investment. It carries a coupon rate of 1.125%, which was set by the originating auction on Jan. 19, when investors got a real yield to maturity of 1.22%. In its first reopening auction, on March 23, investors got a real yield of 1.182%.

This week’s auction looks likely to get a better result. CUSIP 91282CGK1 trades on the secondary market, and according to Bloomberg’s Treasury Yields listing, it closed Tuesday with a real yield of 1.33% and a price of 99.30 for $100 of value.

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.

CUSIP 91282CGK1 will have an inflation index of 1.01319 on the settlement date of May 31, so investors at this point would be paying about $100.61 for $101.32 of principal. That’s a rough estimate. The actual yield and cost will be determined by Thursday’s auction.

I was a buyer of this TIPS at the originating auction and I will likely to add to the holding at Thursday’s auction. A real yield around 1.33% — if it holds — will be a decent result. (I won’t make a purchase order until later Wednesday.)

Here’s a chart of the 10-year real yield trend over the last 13 years, showing how aggressive bond-buying by the Federal Reserve suppressed real yields through much of that time:

Click on image for a larger version.

At this point, even though yields are down from their late 2022 highs, 10-year real yields remain near their highest levels in a decade. This looks like a sensible investment.

Inflation breakeven rate

With a nominal 10-year Treasury note currently trading at 3.53%, CUSIP 91282CGK1 is trading today with an inflation breakeven rate of 2.20%, which seems reasonable. That means investors are pricing in inflation of 2.2% over the next 9 years, 8 months. If you think inflation will be higher, buy the TIPS. If you think it will be lower, buy the nominal Treasury.

Here is the trend in the 10-year inflation breakeven rate over the last 13 years:

Click on image for a larger version

Inflation expectations have been sliding lower in recent months, making TIPS a more attractive investment versus the nominal Treasury, in my opinion.

Final thoughts

I am writing this Tuesday afternoon from an airport hotel in Quito, Ecuador. In a few hours I will be boarding a redeye flight back to the United States. We’ve been boating, hiking and snorkeling around the Galápagos Islands for the last 8 days. After the first night we had zero internet. Nothing. So I’ll admit I have no idea what is going on in the financial markets.

But it was a relief to see that the TIPS market didn’t go sour in the last week. I am looking forward to Thursday’s auction, which will close at 1 p.m. EDT. If you have updates or opinions on the current financial chaos, post them in the comments section below.

If you are considering bidding at Thursday’s auction, I suggest you keep an eye on Bloomberg’s Current Yields to track the yield trend. 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.

Here’s a history of 9- to 10-year TIPS auctions back to 2019:

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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 Inflation, Investing in TIPS, TreasuryDirect | 10 Comments

U.S. inflation increased 0.4% in April, continuing a gradual downward trend

Posted on May 10, 2023 by Tipswatch

By David Enna, Tipswatch.com

Here’s a quick overview of today’s inflation report:

The Consumer Price Index for All Urban Consumers (CPI-U) rose 0.4% in April on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 4.9%.

Core inflation, which removes food and energy, increased 0.4% for the month and 5.5% year over year.

All of these numbers either matched or came close to economist estimates, so no surprises. Although inflation increased 0.4% in April, up from 0.1% in March, the annual all-items number declined from 5.0% to 4.9%, a slight bit of good news. The annual inflation rate has now fallen 11 months in a row. More worrisome is the fact that core inflation is holding steady around 5.5%. Here is a look at all-items and core inflation over the last year:

The BLS noted that the index for shelter (up 0.4% for the month and 8.1% for the year) was the largest contributor to the monthly all items increase, followed by increases in the index for used cars and trucks (up 4.4% for the month) and the index for gasoline (up 3.0%). Food prices, which have been moderating in recent months were up 0.4% for the month and 4.9% year over year. The BLS said the cost of food at home showed no change in April.

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 for TIPS and set future interest rates for I Bonds. For April, the BLS set the inflation index at 303.363, an increase of 0.51% over the March number.

For TIPS. The April inflation report means that principal balances for all TIPS will increase 0.51% in June, after increasing 0.33% in May. For the 12 months ending in June, principal balances will have increased 4.9%. Here are the new June inflation indexes for all TIPS.

For I Bonds. The April inflation report is the first of a six-month string that will determine the I Bond’s new variable rate, which will be reset Nov. 1, 2023. So far, one month in, inflation has been running at 0.51%.

One thing to keep in mind as we continue into summer is that non-seasonally adjusted inflation tends to run higher than seasonally-adjusted from January to June, and then lower from July to December. So the next couple months could indicate a higher number than reality. Here are the data:

View historical data on my Inflation & I Bonds page.

What this means for future interest rates

There’s nothing in this April inflation report that would take the Federal Reserve off its course to hold the federal funds rate in the range of 5.00% to 5.25%. The April numbers matched expectations, and even though annual all-items inflation is gradually declining, inflation remains unacceptably high.

Final thoughts

I am writing this on board a 16-passenger ship moored just off of the town of Puerto Villamil on Gallapagos’s Ilsa Isabela. Today I was lucky enough to have a very slight internet connection; enough to get this posted. But first, I went snorkeling in a pretty area accompanied by four or five friendly and curious sea lions. It’s been a good trip so far.

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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, I Bond, Inflation, Investing in TIPS, Savings Bond | 14 Comments

I’m in Ecuador. What’s happening in the rest of the world?

Posted on May 8, 2023 by Tipswatch

By David Enna, Tipswatch.com

I’ve just returned to Quito, Ecuador’s capital city, after spending five days in the Amazon jungle at a surprisingly pleasant eco lodge on a tributary of the Napo River.

My favorite sighting so far: the Hoatzin (a lot of them).

The good news: We saw four different types of monkeys, 40+ species of colorful birds, gorgeous wild plants, a bunch of giant rodents and two tarantulas. The bad news: My internet access was extremely limited and even now is quite slow. Next week will probably get much worse, so I thought I’d better take the time now to catch up on financial events of the last week.

The Fed

I haven’t been able to closely follow the Fed’s actions or listen to Powell’s press conference. But from what I can gather, the Fed decided to raise its federal funds rate 25 basis points, to a range of 5.00% – 5.25% and then call a halt, at least temporarily.

I like this move and it is what I expected as the United States continues slogging through a slow-motion banking crisis. It does mean that short-term interest rates will be slightly higher than current U.S. inflation (now at 5.0% annually). Of course, this week’s April inflation report could change that equation. I think the Fed knows troubled times are coming, because of …

The debt-limit crisis

I saw that the Treasury Secretary Janet Yellen theorized that the x-date for hitting a hard debt limit could come as soon as June 1, or possibly early July. That was earlier than expected and not good news. Congress remains deadlocked and no compromise looks possible. A more likely result will be a temporary extension of the debt limit, possibly through September, to allow more time for serious talks.

This debt limit fiasco seems to have had little effect — so far — on the U.S. stock market, which finished last week down about 0.8%. Not bad. Of course, the Fed decision to halt interest rate increases was a counter-balancing positive for the market.

T-bill yields

I have written about how similar debt-ceiling events in 2011 and 2013 caused brief disruptions in short-term Treasury yields, with investors demanding higher yields because of the potential turmoil. In recent weeks, we saw this brewing right before our eyes with investors pouring into 4-week T-bills (in theory maturing before the crisis) and demanding higher yields on 8-, 13- and 26-week T-bills, which looked likely to get caught in the political mess.

Now, with Yellen announcing a potential x-date of June 1, that situation has reversed, and the 4-week T-bill is now most at risk. The result: Last week’s 4-week Treasury auction got an investment rate of 5.964%, up an incredible 206 basis points from 3.905% the week before.

Click on image for larger version.

This trend is likely to continue — and worsen — as a true hard debt limit looms over the market in coming weeks.

Real yields

I’m pleased to see that nothing “major” has been happening with real yields of Treasury Inflation-Protected Securities as we approach the next TIPS auction, the May 18 reopening auction of CUSIP 91282CGK1, a 10-year TIPS.

The 10-year real yield is holding at 1.23%, down about 13 basis points since the beginning of May. At this point, that auction still looks attractive, but it also makes the current I Bond with a fixed rate of 0.9% look very competitive.

Click on image for larger version.

The most interesting trend from February to May 2023 has been the widening of the long end of the TIPS yield curve. I have been expecting that to happen as the Fed begins winding down this tightening cycle. But I am not expecting yields to decline much on the short end. We’ll see.

Wednesday’s inflation report

Consensus estimates are pointing toward April inflation coming in at 0.4% for the month and 5.0% for the year, which would hold steady with the March number. Core inflation is expected come in at 0.4% for the month and 5.5% year-over-year. None of this can be viewed as “good news,” and if inflation comes in higher than expected, it could rile financial markets.

The U.S. dollar

In Ecuador, the official currency is the U.S. dollar for all transactions. This country widely uses the U.S. $1 coin, which you rarely see in the United States. The U.S. dollar gives this nation a stable economic base for foreign investment, as long as exports are strong. Oil is the largest export at 32% of all exports, and yes, drilling is expanding in the Amazon region.

One predictable side effect of the combination of the Fed rate-hike halt and looming debt crisis is a decline in the value of the U.S. dollar, which has lost 2.3% of its value year to date. A weaker dollar creates an inflationary trend, which could counteract some of the Fed’s attempts to slow inflation. This is a trend to watch.

My schedule

By Wednesday morning I will be in the Galapagos Islands and facing highly uncertain internet connections and shifting schedules for activities. I am not sure when I will be able to post an analysis on the CPI report or preview article on the May 18 TIPS auction. In addition, I may have trouble approving and responding to your comments. Be patient!

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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 | 20 Comments