Treasury Inflation-Protected Securities

• TIPS on the secondary market: Things to consider

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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 Bank CDs, Inflation, Investing in TIPS, Retirement, Treasury Bills | 54 Comments

30-year TIPS reopening gets real yield of 1.970%, highest in 12 years

Posted on August 24, 2023 by Tipswatch

By David Enna, Tipswatch.com

The Treasury’s $8 billion reopening auction of CUSIP 912810TP3 — creating a 29-year, 6-month Treasury Inflation-Protected Security — went off pretty much as expected Thursday, generating a real yield to maturity of 1.970%.

While that result fell just short of a milestone 2.0% real yield, it was higher than where this TIPS was trading most of the morning, at about 1.93% to 1.94%. So investors should be pleased. The real yield of 1.970% was the highest for any 29- to 30-year TIPS auction since February 2011.

This TIPS had its originating auction on Feb. 16, 2023, which generated a real yield of 1.550% and set the coupon rate at 1.50%. So, six months later, real yields for this term have increased 42 basis points. And that means this TIPS sold today at a discount, because of the wide gap between the auctioned real yield (1.970%) and the coupon rate (1.50%).

Investors got an unadjusted price of 89.533532 for $100 of value. The inflation index on the settlement date of Aug. 31 will be 1.02632, pushing the adjusted price to 91.890055, still well below par value.

In essence, investors paid about $91.89 for about $102.63 of principal, and will now collect accruals to principal matching U.S. inflation, along with 1.5% annual interest on the inflation-adjusted principal. Here is how the pricing worked out:

Inflation breakeven rate

With a nominal 30-year Treasury bond trading today at 4.29%, this TIPS gets an inflation breakeven rate of 2.32%, which is in line with the February result but higher than other auctions of this term over the last decade. Investors in this TIPS are betting that inflation will average higher than 2.32% over the next 29 years, 6 months.

As this chart shows, 30-year inflation expectations have been rising since 2020, but have been in a range of 2.2% to 2.4% for the last several months:

Reaction to the auction

The bid-to-cover ratio was 2.42, which indicates reasonable demand. The yield came in fairly close to secondary market trading, so by all indications this auction went off without a hitch.

After strong increases in real yields over the last two weeks, the trend turned slightly downward on Wednesday, with the Treasury’s 30-year real yield estimate falling from 2.07% on Tuesday to close at 1.93% on Wednesday. So today’s end result of 1.97% looks like a positive auction for investors.

Here is the trend in recent TIPS auctions of this term:

• Now is an ideal time to build a TIPS ladder

• TIPS on the secondary market: Things to consider

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Posted in Investing in TIPS | 12 Comments

For some, this week’s 30-year TIPS reopening will be a ‘unique’ opportunity

Posted on August 20, 2023 by Tipswatch

By David Enna, Tipswatch.com

One of the year’s most interesting TIPS auctions is coming Thursday, the reopening of CUSIP 912810TP3, creating a 29-year, 6-month Treasury Inflation-Protected Security. Like many of you, I won’t be a buyer at this $8 billion offering. But for some, this TIPS offers a unique investment opportunity.

I say unique, but that could mean uniquely positive (a good possibility) or uniquely awful (there’s always that chance). But either way, this auction will be unique because it is likely to generate a real yield to maturity of close to 2.0%, or higher. No TIPS auction of the 29- to 30-year term has nabbed a real yield that high since February 2011, when a new issue got a real yield of 2.190%. Just two years ago, a similar August auction got a real yield of -0.292%.

CUSIP 912810TP3 trades on the secondary market, and Bloomberg’s U.S. Yields page shows it closed Friday with a real yield of 2.08%. If that holds on Monday, an investor could bypass Thursday’s auction and lock in a 2% yield over inflation. Or … just wait for the auction and get its result.

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.

Here is the trend in the 30-year real yield going all the way back to February 2010, when the Treasury restarted the 30-year maturity after an 8 1/2-year pause:

The chart show the 30-year real yield only briefly topped 2% during this entire period, in 2010 and early 2011, and again in August 2023.

Some cautions

As I noted, I won’t be a buyer of this TIPS because it will mature when I am 99 1/2 years old. It doesn’t fit into my hold-to-maturity strategy. For others — age 60 or younger — it could fit as the top piece of a multi-year TIPS ladder.

It’s important to recognize the volatility of any 30-year Treasury investment. Even small swings in market real yields can cause substantial changes in the market value of a TIPS. For example, CUSIP 912810TP3 originally auctioned on Feb. 16, 2023, with a real yield of 1.55%, which at the time was the highest auction result in nearly 12 years. That set the coupon rate at 1.5% and the adjusted price was about 98.66 for $100 of value.

Fast forward six months and today that same TIPS has a real yield of 2.08% on the secondary market and its market price has dropped to about 87.34. So this TIPS has lost about 11.5% of its value in only six months. The lesson here is that long-maturity Treasurys are highly volatile; an investor has to recognize that going in. However, if the plan is to hold to maturity and collect 2.0% above inflation, market values aren’t much of a concern. Focus on the plan.

Also, I highly recommend purchasing any long-term TIPS in a tax-deferred account. In a taxable account, yearly inflation accruals of a TIPS (which are added to the principal balance) will be taxed each year as interest income. You won’t recoup that money until the TIPS is sold or matures after 29 1/2 years.

Pricing

On the auction’s settlement date of Aug. 31, CUSIP 912810TP3 will have an inflation index of 1.02632, which means auction investors will be buying about 2.6% additional principal. So an investor purchasing $10,000 par of this TIPS would actually be purchasing $10,263.20 of principal. At Friday’s closing price of 87.34, that principal would cost $8,963.88. Add in about $6.66 of accrued interest and you get to $8,970.54 total cost.

In essence, the investor is paying about $8,964 for $10,263 in principal, plus getting accruals to principal matching inflation for 29 1/2 years, plus collecting a 1.5% coupon along the way. This is a rough estimate based on Friday’s closing market value.

An inflation index of only 1.026 is another reason this long-term TIPS is unique. Because of very high recent inflation, the TIPS maturing in Feb 2052 has an inflation index of 1.094 (9.4% above par) and the one in Feb 2051 is at 1.170 (17% above par). Both of those TIPS also have coupon rates of just 0.125%, the lowest the Treasury will go, compared to 1.5% for CUSIP 912810TP3.

Inflation breakeven rate

With the nominal 30-year bond closing Friday at 4.38%, a 30-year TIPS yielding 2.08% would get an inflation breakeven rate of 2.3%, which is historically high but in line with February’s originating auction. Would I rather invest in a 30-year nominal paying 4.38%? Probably not, but for some this could be a toss up.

Here’s the trend in the 30-year inflation breakeven rate over the last 13 years, showing the range-bound pattern over recent months:

Final thoughts

I found an interesting article this week posted by Bloomberg on Yahoo Finance. The headline was: “Inflation-Protected Bond Bulls’ Pain Thresholds Get Tested.” It told how market strategists from TD Securities made a bet on 5-year real yields declining in the near future, hoping for a quick capital gain.

They targeted an improvement to 1.25%, expecting no further Federal Reserve interest-rate hikes and deceleration in US growth and inflation. Three weeks later, the stop-loss threshold of 2.20% was reached as those assumptions came under assault. …

Still, there’s scope for losses to deepen before support emerges, Dominic Konstam, head of macro strategy at Mizuho Securities, said in a Thursday interview on Bloomberg Television.

“There’s a limit to how far you can sell off,” he said. “Five-year real rates are pretty chunky at the moment, and if they go up another 20, 30 basis points that’s going to be quite attractive I imagine for a lot of investors.”

Why is that interesting? Because savvy market strategists got burned by betting on 5-year TIPS, the least volatile of the TIPS issues. Any bet on 30-year TIPS would have been hugely magnified, and hugely unwise.

I am not a TIPS trader and I don’t theorize on TIPS trades. It is possible that CUSIP 912810TP3 could end up being a big winner for traders, or a big loser. The only way I advise investing in CUSIP 912810TP3 is in a hold-to-maturity strategy, with full awareness of the potential losses (or possible gains) if you need to exit early.

An investor in CUSIP 912810TP3 this week can very likely lock in a 2.0% yield above official U.S. inflation for the next 29 1/2 years. And that is unique.

If you are pondering an investment at Thursday’s auction, keep an eye on Bloomberg’s U.S. Yields page, which updates in real time. It is accurate, but any auction result can bring surprises.

Thursday’s auction will close at 1 pm 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.

• Now is an ideal time to build a TIPS ladder

• TIPS on the secondary market: Things to consider

Here is a history of recent TIPS auctions of the 29- to 30-year term:

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Posted in Inflation, Investing in TIPS, TreasuryDirect | 45 Comments

Now is an ideal time to build a ladder of inflation-protected TIPS

Posted on August 14, 2023 by Tipswatch

It’s rare to see an alignment of attractive yields across all maturities.

By David Enna, Tipswatch.com

For years, I was the “buy at auction” guy when it came to Treasury Inflation-Protected Securities. I’ve written a preview article about every auction since April 2011, so that made sense. I was tracking trends, and figured “I’m on top of this.”

But buying at auction limits you to 5-, 10- and 30-year TIPS maturities, and there are only 12 auctions a year. In the last few years, I began the process of building out a ladder of TIPS investments through the year 2043. I realized “this isn’t working.” At times, real yields weren’t attractive. Other times, they were very attractive. Limiting purchases to one maturity a month didn’t make sense.

Why buy at auction? A TIPS investor can make a purchase of just $100 at TreasuryDirect (or $1,000 at most brokerages) and be guaranteed to get the auction’s high yield, the same yield a million-dollar investor gets. On the secondary market, smaller purchases — usually meaning less than $100,000 — get a small penalty in real yield. A typical rule is that the bigger the investment, the higher the real yield. But the differences aren’t dramatic.

One negative of buying at auction, though, is that you can’t predict exactly the real yield you will receive. The auction sets the yield. A year ago, a string of TIPS auctions got higher real yields than expected. But that has reversed in recent months as demand for TIPS seems to be growing.

Why buy on the secondary market? 1) You can choose your preferred maturity date (which is ideal for building a TIPS ladder), 2) you can see the exact real yield you will receive and 3) you can see the exact cost of the investment before you hit “submit.” At the big brokerages — Vanguard, Fidelity and Schwab — secondary Treasury market purchases incur zero commissions.

One negative of the secondary market, as I noted earlier, is the bid-ask spread and sometimes lofty minimum purchase requirements. There will be times you can’t find any seller willing to accept a $10,000 purchase. The solution: Come back the next day and things can change.

Buying on the secondary market can be confusing. Every existing TIPS has a set coupon rate, sells at a discount or premium to par, and has some level of inflation accruals that you will be purchasing in addition to par. All those factors will affect the price you pay, and an investor needs to understand the ins-and-outs.

If you have questions, consult my TIPS In-Depth page for more detailed answers. Also, read this: TIPS on the secondary market: Things to consider.

Why now?

This chart, showing TIPS real yields from 2011 to 2023, pretty much tells the story:

I started this chart in 2011 because that was the first year of truly aggressive quantitative easing by the Federal Reserve, which by the end of the year pushed 5- and 10-year real yields deeply negative to inflation. Oddly enough, that session of QE was triggered by a downgrade of U.S. Treasurys by Standard & Poors on Aug. 6, 2011, which set off a severe decline in the U.S. stock market.

Less than a month ago, Fitch Ratings matched the S&P move of 12 years ago, downgrading U.S. debt to AA+ from AAA. While the 2011 move by S&P set off a rally in the bond market (presumably triggered by the Fed) this year’s downgrade has sent both nominal and real yields rising. The Fed can’t and won’t come to the rescue — and in fact is probably fine with higher bond yields.

What’s remarkable about this chart is the fact that real yields across the spectrum of maturities are aligning close to 2%, traditionally an attractive yield above inflation for any Treasury investment. It’s highly unusual to see that sort of alignment for maturities ranging from 5 to 30 years.

Here is the 2023 trend in real yields across popular TIPS maturities:

A ladder-building opportunity

The investment world — which rarely pays attention to TIPS and real yields — is starting to take notice. A Bloomberg article posted on Yahoo Finance this week had the headline: “Lesser-Known Treasury Yield Is on Brink of Historic Breakthrough.” The article noted:

The yield on 30-year inflation-protected Treasuries is on the cusp of exceeding 2% for the first time in more than a decade. … For some, a 2% “real yield” is a screaming buy … For others, uncertainty about whether inflation has peaked — combined with the US government’s growing borrowing need — means that all types of long-term yields may need to be higher still. …

“Our message is get into bonds, both nominal and real,” said Rob Waldner, chief strategist fixed income at Invesco.

Real yields certainly could continue to rise, but in mid-August 2023 an investor can jump into the secondary market and purchase TIPS of most maturities and guarantee a return of 1.8% above inflation, or higher. So a ladder could be assembled in a few days, as financial adviser and author Allan Roth demonstrated in his October 2022 article: “The 4% Rule Just Became a Whole Lot Easier.”

Roth wrote that article as real yields were hitting a high for 2022, but those yields quickly declined later in the year in the wake of several mild inflation reports. Note that today’s real yields have now surpassed the 2022 highs across all maturities:

My TIPS ladder is complete through 2043, but I’ve gotten into the habit of checking the secondary market every day for issues with real yields close to or surpassing 2.0%. I still want to make additions. (FYI, I do my trading on Vanguard’s site — where I have a traditional IRA — but I believe the Fidelity bond platform provides more complete information.)

On Sunday, I found these TIPS with real yields above 2.0%, but the results vary day to day. Some days you will find none. I limited the search to TIPS maturing from 2028 to 2043:

The bond market is closed on Sunday and all of these TIPS had minimum purchase requirements of $50,000 or higher. Normally, but not always, the minimum purchases get lower when bond trading is active. On Vanguard’s site you can click on the “Show more” link to see the potential offerings. In recent months I have had few problems finding potential purchases in the $10,000 range.

Note that these TIPS yielding higher than 2.0% have maturity ranges dating from 2028 to 2043. But for 10-year TIPS, the yields are likely to be around 1.8% at this point, which is still attractive. (The auction of a new 10-year TIPS last month got a real yield of 1.495%, about 30 basis points lower.)

Final thoughts

I am not suggesting pouring all your investable money into a TIPS ladder, all at once. But if you are currently building a TIPS ladder, or want to start one, real yields in August 2023 offer a unique opportunity, with yields high across all maturities.

Remember, though, that real yields could go higher. My suggestion is to determine an asset allocation for TIPS and invest in them with the intention to hold to maturity. If you are happy with the real yield you are getting, don’t worry about future market fluctuations. Or … reserve cash to buy more at a future date.

• TIPS on the secondary market: Things to consider