Treasury Inflation-Protected Securities

This week’s 10-year TIPS reopening auction still looks attractive

Posted on March 19, 2023 by Tipswatch

But be prepared for another wild week.

By David Enna, Tipswatch.com

I know how disappointing it can be to be waiting to pull the trigger on an investment in a Treasury Inflation-Protected Security, only to see real yields slide lower, making that TIPS less attractive.

It happens. And that’s why I think it is a sensible strategy to make investments regularly as long as real yields are historically reasonable. And that brings us to CUSIP 91282CGK1, which will be reopened at auction on March 23, creating a 9-year, 10-month TIPS. The Treasury is offering $15 billion of this reopened TIPS.

Two months ago, on Jan. 19, this TIPS had an originating auction that generated a real yield to maturity of 1.22%, a bit disappointing. But then real yields started climbing, with the 10-year real yield hitting a year-to-date high of 1.66% on March 8, making the upcoming March 23 auction look highly attractive.

And then, a day later, we got a banking crisis and a Federal Reserve bailout, sending real yields plummeting. The smoke hasn’t cleared, but as of Friday’s market close, CUSIP 91282CGK1 was trading with a real yield to maturity of 1.33%, down about 33 basis points in a week but still 11 basis points above the yield of the Jan. 19 originating auction.

So, despite the turmoil, CUSIP 91282CGK1 still looks like a perfectly acceptable investment, in my opinion. Of course, we’ll have to wait to see how the bond market roils in coming days. This is a time of high volatility.

One thing to be aware of (or … should I say beware of?) is that the Federal Reserve will make an interest rate announcement Wednesday at 2:15 p.m. ET and also announce its future rate forecasts. Odds are that the Fed will opt to continue 25 basis-point increases, but this is highly uncertain. The announcement and forecasts come less than 24 hours before the TIPS auction closes at 1 p.m Thursday. Things could get shaken up.

If you are interested in investing in CUSIP 91282CGK1, you can check its current real yield in real time on Bloomberg’s Current Yields page. This data won’t perfectly predict Thursday’s auction result, but it should end up reasonably close.

Here is the trend in the 10-year real yield from the beginning of 2019 (at the end of the Fed’s last tightening cycle) to March 2023 as the Fed continues its newest tightening cycle:

Click on the image for a larger version.

Here’s the point: As long as 10-year real yields sustain above 1%, they remain attractive as an investment. We can’t know the direction of future interest rates. But current rates are at least historically attractive.

Update on pricing

I just checked Monday morning (Montenegro time) and CUSIP 91282CGK1 was trading with a real yield of 1.24% and price of 98.99 for $100 of value. This TIPS will have an inflation index of 1.00409 on the settlement date of March 31. So an investor purchasing $10,000 in par value will be actually buying $10,040.90 of accrued principal. Apply a price of 0.9899 and you get a total cost of $9,939.48. Of course, this will change before Thursday’s auction close.

Inflation breakeven rate

With the 10-year Treasury note closing Friday with a nominal yield of 3.43%, CUSIP 91282CGK1 currently has an inflation breakeven rate of 2.1%, lower than recent trends. In fact, it seems remarkably low at a time when U.S. inflation is sustaining at 6.0%.

This breakeven rate means that the TIPS will outperform the nominal Treasury as long as inflation averages more than 2.1% over the next 9 years, 10 months. Over the last 10 years, U.S. inflation has averaged 2.6%.

Here is the trend in the 10-year inflation breakeven rate over the last three years, showing that 2.1% looks reasonable when compared with the recent trend line:

Final thoughts

I am writing this on Saturday afternoon in beautiful Dubrovnik, Croatia (a nation where annual inflation is currently running at 12%). This is another reminder that inflation is a global issue, not caused — or solved — completely by U.S. policies. Because of this trip, I decided to skip this TIPS reopening auction. Instead, 10 days ago I bought a TIPS on the secondary market, maturing in January 2032. I nabbed a real yield of 1.66%. Now it is trading at 1.29%.

That was luck, not investing skill. But the lesson was to take advantage of favorable real yields when you see them. If 10-year real yields hold around 1.3% before Thursdays auction, I think CUSIP 91282CGK1 will be an acceptable addition to your TIPS collection.

And yes, I did buy CUSIP 91282CGK1 at the originating auction with a real yield of 1.22%. That one wasn’t so lucky, but it was fine. It all balances out.

If you are considering bidding at Thursday’s auction, I urge you to 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.

I’ll be posting results sometime Thursday (I hope), but because of iffy internet on this trip, it will be impossible to predict when. 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 Federal Reserve, Inflation, Investing in TIPS, TreasuryDirect | 21 Comments

Bond market shakeup: Where we stand today

Posted on March 16, 2023 by Tipswatch

By David Enna, Tipswatch.com

Even though I am now in beautiful but very windy Split, Croatia, this morning, I couldn’t resist the temptation to check in on Treasury Inflation-Protected Securities after an incredibly volatile week.

Over the last year, I have been recommending investing in TIPS with a sense of urgency, because we couldn’t be sure how long these attractive real yields would last. In 2019, the last time the Federal Reserve ended a tightening cycle, real yields declined quickly. And then came the Covid pandemic, leading to aggressive Fed stimulus and real yields falling deeply negative to inflation.

At this point of 2023, we are still seeing real yields at “fairly” attractive levels, but well below recent 2023 highs reached just last week. Here is the trend since March 8:

In this amazing week we saw: First a financial crisis caused by banks taking unneeded risks on long-term Treasurys for a minimal gain in yield, and second, a Federal Reserve bailout of depositors who were taking unneeded risks by concentrating deposits in a single “friendly” bank.

Bitcoin price chart, Feb. 22 to March 12.

The moral of this story is that if you are big enough, there is apparently no risk in risk. And the markets heard this, loud and clear. The result was exactly opposite of what the Federal Reserve wants: Unfettered demand for highly risky assets like bitcoin, which has soared in the last week.

Are the Fed, Treasury and FDIC now tacitly guaranteeing all deposits at all FDIC-insured banks, above the current limit of $250,000? It appears this is true for some period of time.

Bond investors, though, are ignoring the green light to risk and have been piling into the safety of TIPS and other U.S. Treasurys, resulting in the dramatic fall in real and nominal yields. Since March 8:

5-year real yields have fallen from 1.87% to 1.26%, a decline of 61 basis points.
10-year real yields have fallen from 1.66% to 1.22%, a drop of 44 basis points.
30-year real yields have fallen from 1.62% to 1.44%, a drop of 18 points.

The fact that 5-year real yields have fallen the most seems to indicate the market is expecting the Federal Reserve will now halt its increases in short-term interest rates, and that does look likely in the short term. But the Fed is walking a tightrope as it continues to battle U.S. inflation, which is still running at an annual rate of 6%.

There is a definite possibility that the Fed’s injection of money into the financial system could be inflationary. From a Bloomberg article today:

Market observers are on alert to find out just how much extra funding the Federal Reserve’s new bank backstop program will ultimately add into the system, with analysts at JPMorgan Chase & Co. positing that it could inject anywhere up to $2 trillion in liquidity.

Inflation analyst Michael Ashton notes that the February inflation report doesn’t leave the Fed with a lot of room for error:

A nice, soft inflation report would have allowed the Fed to gracefully turn to supporting markets and banks, and put the inflation fight on hold at least temporarily. But the water is still boiling and the pot needs to be attended. I think it would be difficult for the Fed to eschew any rate hike at all, given this context. However, I do believe they’ll stop QT – selling bonds will only make the mark-to-market of bank securities holdings worse.

Will the Fed opt to ease troubled financial conditions? Or will it opt to continue an aggressive fight against inflation? Investors at this point seem to think inflation is going to be set aside as the top priority. In this chart, note that the TIPS market, represented by the TIP ETF, has moved from under-performing the overall bond market in late February, to out-performing based on the last week’s surge.

This is good news for holders of TIP ETFs and mutual funds, which suffered severe losses in 2022. The overall TIPS market is doing well as investors see the possibility of stronger inflation ahead if the Fed changes course.

Are TIPS still attractive? I think they are. These current levels remain reasonable, in my opinion, even if they aren’t quite as attractive. It’s impossible to say if real yields will level off, continue falling, or potentially begin to rise again.

In early morning trading today, the most recent 10-year TIPS has a real yield of 1.17%, a bit below the yield of 1.22% at its originating auction on Jan. 19, 2023. That TIPS will reopen at auction on Thursday, March 23. I will be posting a preview of that auction on Sunday morning.

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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.

Posted in Federal Reserve, Inflation, Investing in TIPS | 26 Comments

U.S. inflation increased 0.4% in February; annual rate falls to 6.0%

Posted on March 14, 2023 by Tipswatch

By David Enna, Tipswatch.com

I am writing this posting after just arriving in Zadar, Croatia. My time is short, so I will need to be brief this month.

The Consumer Price Index for All Urban Consumers rose 0.4% in February on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 6.0%. Those numbers matched consensus estimates, but core inflation ran slightly higher than expected, at 0.5% for the month, versus the estimate of 0.4%.

The index for shelter was the largest contributor to the monthly all items increase, accounting for over 70% of the increase, the BLS said, with the indexes for food, recreation, and household furnishings and operations also contributing.

This report ended up close to expectations. The shelter index continues to run hot (up 8% for the month and 8.1% for the year), but this is a lagging indicator and should begin sliding lower in future months. The annual increase in the all-items index of 6.0% was the lowest 12-month increase since the period ending September 2021. The core increase of 5.5% was the smallest since December 2021.

Gasoline prices were up 1% for the month, but have fallen 2.0% over the last 12 months. Food prices were up 0.4% for the month and 9.5% for the year.

Here is a one-year look at trends for all-items and core inflation, showing the gradual decline in core inflation versus a steeper decline for all-items:

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 300.840, an increase of 0.56% over the January number and 6.0% year-over-year.

For TIPS. The February inflation report means that principal balances for TIPS will increase 0.56% in April, after rising 0.80% in March. Here are the new April Inflation Indexes for all TIPS.

For I Bonds. February is the fifth month of a six-month string that will determine the I Bond’s new inflation-adjusted variable rate. Through the five months, inflation has run at 1.36%, which would translate to a variable rate of 2.72%. One month remains, so it looks like the new variable rate should fall into a range of about 3.2% to 3.5%, down substantially from the current 6.48%. The I Bond’s fixed rate will also be reset May 1, but the outlook for that reset is highly uncertain, given the volatility of real yields over the last week.

Here are the relevant numbers:

View historical data on my Inflation and I Bonds page.

Sorry, but this is all I have time for on this busy travel day. I hope to post more later this week.

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Posted in I Bond, Inflation, Investing in TIPS, Savings Bond | 8 Comments

My schedule … and what’s coming next

Posted on March 12, 2023 by Tipswatch

By David Enna, Tipswatch.com

I am traveling for the next 2 1/2 weeks in a far-off land with a Mediterranean climate (I hope this applies to March), a beautiful coastline, amazing historical sites and hearty foods like Čobanac.

Its flag is one of my favorites in the world. Want to guess the country?

Of course, the trip means my internet access is going to be iffy for much of this time, and my schedule is going to be crowded through late March. So I won’t be able to update this site as frequently or as thoroughly as usual. I will try to check in to answer questions when I can, but that could also be iffy.

To add to the confusion, daylight savings time begins today (March 12) in the United States, but not until March 26 in the Central European Time zone. Oh, and by March 26 I will be in the Eastern European Time zone, doubling my dizziness.

But … the news never stops

March 14, 8:30 a.m. ET. The Bureau of Labor Statistics will release the February inflation report. This will be a crucial report. It will help set the course for future Federal Reserve actions on inflation, and also be the fifth of six monthly reports that will determine the I Bond’s new variable rate.

The Cleveland Fed is nowcasting a monthly inflation rate of 0.54% for February and annual inflation of 6.21%. Its core forecast is 0.45% for the month and 5.54% for the year. These Cleveland Fed numbers haven’t been highly accurate recently, and I haven’t yet seen other consensus estimates.

Most likely, when the inflation report is released Tuesday, I will be hiking in a nature preserve or sitting on a bus, heading for the coast. I will try to post the news and analysis as soon as I can, in whatever form I can.

March 19, 8 a.m. ET. At this time, I am planning to post my preview article on the 10-year TIPS reopening auction scheduled for Thursday, March 23. This one has been looking promising, after the originating auction on Jan. 19 got a “disappointing” real yield of 1.22%. The March 23 auction should get a better result, but real yields have been declining in recent days.

March 23, 1 p.m. ET. I’ll try to post the 10-year TIPS auction results as soon as I can. At that time (7 p.m. CET) I might be in the middle of a hearty dinner or finishing a fourth glass of wine. So take note: accuracy could be an issue.

Last week’s banking news

I have been out of the country during several economic collapses, so I get touchy when I see headlines like “Why Silicon Valley Bank’s crisis is rattling America’s biggest banks.” It reminds me of the hundreds of times I have heard CNBC commentators say the Federal Reserve would keep raising rates until “something breaks.”

Did something just break?

An interesting side to this story is the fact that banks were loading up on ultra-safe U.S. Treasurys during the era of near-zero interest rates. Now that the free-money era has ended, those Treasurys have declined sharply in value. But, as the Wall Street Journal reports:

Banks don’t incur losses on their bond portfolios if they are able to hold on to them until maturity. But if they suddenly have to sell the bonds at a loss to raise cash, that is when accounting rules require them to show the realized losses in their earnings. Those rules let companies exclude losses on their bonds from earnings if they classify the investments as “available for sale” or “held to maturity.” …

“This is the first sign there might be some kind of crack in the financial system,” said Bill Smead, chairman and chief investment officer of Smead Capital Management, a $5.5 billion firm that counts Bank of America Corp. and JPMorgan among its holdings. “People are waking up to the gravity that this was one of the biggest financial euphoria episodes.” …

The Federal Deposit Insurance Corp. in February reported that U.S. banks’ unrealized losses on available-for-sale and held-to-maturity securities totaled $620 billion as of Dec. 31, up from $8 billion a year earlier before the Fed’s rate push began.

This adds some perspective to the Federal Reserve’s somewhat controversial plan to reexamine banks’ capital reserves, a topic Fed Chairman Jay Powell got hammered on in last week’s congressional testimony. Powell absolutely could not say “there is a problem.” I just hope there isn’t a problem.

I am also hoping (as always) that we won’t see financial chaos while I am trying to enjoy my Mediterranean adventure. I’ll just close with a picture I took in 2018 in another country I am visiting on this trip:

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Posted in I Bond, Inflation, Investing in TIPS | 23 Comments

I Bonds: Let’s handicap the May fixed-rate reset

Posted on March 9, 2023 by Tipswatch

Everything you are about to read is based on facts … and plain old guesswork.

By David Enna, Tipswatch.com

Update, April 28, 2023: Treasury raises I Bond’s fixed rate to 0.9%; new composite rate is 4.30%

Note, March 13: It has been 5 days since I wrote this article, and while I think it presents a reasonable theoretical way to look at the I Bond’s fixed rate, these predictions are totally shot, at least for now. The 10-year real yield is currently trading around 1.22%, down about 44 basis points in the last 5 days. So … in this troubling environment of bank bailouts, the Fed and markets are likely to change course. Yields leading up to the May 1 decision are likely to be very volatile. (But I think this all still makes a strong case for investing in inflation protection.)

Read this article knowing that it is almost impossible to predict what the I Bond’s fixed rate reset will be on May 1. There are simply too many unpredictable factors.

And now, the original article:

I’ve been getting a lot of questions from readers asking: “Do you think the Treasury will raise the I Bond’s fixed rate on May 1? And what should we do about it?”

It’s still too early to speculate (a lot happens in the bond market every week), but I do think the fixed rate is probably going up on May 1. But by how much? No one can say. The Treasury has no announced formula for setting the I Bond’s rate. It seems to be set based on “whim.” But maybe not totally whim.

First, here are some details about the U.S. Series I Savings Bond, a security that earns interest based on combining a fixed rate and an inflation rate.

The fixed rate will never change. Purchases through April 30, 2023, will have a fixed rate of 0.4%. The fixed rate is essentially the “real yield” of an I Bond, the amount its return will exceed future inflation.
The inflation-adjusted rate (often called the variable rate) changes each six months to reflect the running rate of inflation. That rate is currently set at 6.48% annualized. It will adjust again on May 1, 2023, for all I Bonds, no matter when they were purchased. The starting month of the new rate depends on the month you purchased an I Bond.
The combination of these two rates creates the I Bond’s six-month composite rate, which is currently 6.89% annualized for I Bonds purchased through April 30.

The fixed rate is extremely important for an I Bond investor, especially a long-term investor, because it stays with the I Bond for 30 years, or until the I Bond is redeemed. A higher fixed rate is very desirable.

But even if the fixed rate rises on May 1, if the increase is small — say from 0.4% to 0.6% — an investor still might want to buy in April to lock in the 6.89% interest rate for a full six months. On a $10,000 investment, that equals $344.50 in interest. A 0.2% increase in the fixed rate only adds $20 a year.

It looks likely that the I Bond’s variable rate will fall on May 1. This is uncertain, with two months of inflation unreported, but the variable rate could fall to something like 3.50%. If the fixed rate rises to 0.6%, the new composite rate would be around 4.12%.

So the investment equation is: 6.89% before May 1 and something like 4.12% after May 1. For a short-term investor, buying before May 1 will make more sense. For the long-term holder of I Bonds, buying after May 1 may be wiser. But of course if you wait, you won’t know if the fixed rate is actually going higher. It’s a risk. Or … it could rise somewhere much higher, like 0.8% or 1.0% and you’d be very happy.

Alternatives. Buy half your $10,000 I Bond allocation in April and the other half in May. Or, some investors — those with spouses and two separate TreasuryDirect accounts — could use the “gift box” strategy. Buy your full allocation in April and then, if the fixed rate rises dramatically, use the gift box in May to invest another $10,000 each.

Handicapping the fixed rate

Although the Treasury has no public formula for setting the I Bond’s fixed rate, I have long speculated that the fixed rate will tend to track (although lower) with the real yield of a 10-year Treasury Inflation-Protected Security. Last October, I suggested that the fixed rate was likely to rise to a range of 0.3% to 0.5%, even though a higher fixed rate was justified. The Treasury settled on 0.4%. I got lucky on that prediction.

On October 31, 2022, the 10-year TIPS was yielding 1.58%. The I Bond’s fixed rate generally lags 50 to 75 basis points lower than the 10-year real yield, so a higher fixed rate was justified, in my opinion. But real yields at that point had just recently surged higher. It was hard to forecast a longer-term trend.

Several readers have suggested that the Treasury may take an average of the 10-year real yield over the previous six months and then apply a ratio to that yield to set the I Bond’s fixed rate. I liked that idea, at least in theory. So I took a look at recent rate-setting periods where the fixed rate was set higher than 0.0% to compare the six-month-average theory against the most-recent-yield theory:

OK, to be honest, neither theory works well enough to be relied on as a predictor and that puts us back to the “whim of the Treasury” theory for setting the I Bond’s fixed rate. It says so right in the Federal Register:

The Secretary of the Treasury determines the fixed rate of return. The fixed rate is established for the life of the bond. This amendment clarifies that the fixed rate of return will always be greater than or equal to 0%.

Still, I think market real yields do play a role in this rate-setting exercise.

Half-year average theory. To apply this theory, I determined the average 10-year real yield over the rate-setting periods — May to October and November to April for each period the fixed rate was set above 0.0%. Then I calculated the ratio of the new fixed rate to the six-month average.

In the most recent rate reset in November 2022, the fixed rate of 0.40% was 56% of the 0.72% six-month average for the 10-year real yield. If you applied that ratio to current 10-year real yield average of 1.41%, you get a fixed rate of 0.80%, rounded to the tenth decimal point. (Fixed rates are always set to the tenth decimal point, such as 0.40% currently.)

But … this history of rate resets is highly inconsistent, with the ratio averaging just 34%. If you apply that to the current average of 1.41%, you get a fixed rate of 0.50% (rounded), still higher than the current 0.40%.

The more-recent ratios have tended to fall around 60%, which would give you a fixed rate of 0.80%.

Most recent real yield theory. This theory — which looks at the yield spread between the I Bond’s new fixed rate and the most recent 10-year TIPS yield — is also hugely inconsistent, but it generally does a good job of predicting when the fixed rate is likely to rise or fall.

The fixed rate of 0.4% in November resulted in a yield spread of 118 basis points, the highest margin going back 13 years. It’s possible the Treasury saw the then-recent surge in real yields as temporary, so it held the fixed rate lower than it might have otherwise.

If you apply a spread of 50 to 75 basis points (the average is 67 bps) you get a fixed rate of 0.90% to 1.20%, based on the current real yield of 1.66%.

Conclusion

I think the fixed rate is heading higher, possibly to around 0.6% on the low end and 1.0% on the high end. Let’s just say –er, guess — 0.8%. Feel free to crowdsource your own ideas and theories in the comments sections below.

Plus, remember that a lot can change before May 1, and the Treasury can do anything on a “whim.”

I’ll be taking another look at this issue — and potential I Bond investing strategies — after we learn the new variable rate, which will be set by the March inflation report released on April 12, 2023.

• I Bonds: A not-so-simple buying guide for 2023

• 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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