Treasury Inflation-Protected Securities

Fed president James Bullard gave auction investors a gift today.

By David Enna, Tipswatch.com

Investors in today’s Treasury offering of $15 billion in a 10-year TIPS reopening auction should give a tip of the hat to St. Louis Fed president James Bullard, who shook up the bond market (just a bit) with some hawkish rhetoric on interest rates. According to CNBC:

“Thus far, the change in the monetary policy stance appears to have had only limited effects on observed inflation,” Bullard said. “To attain a sufficiently restrictive level, the policy rate will need to be increased further.”

Bullard contended that 5% could serve as the low range for the where the funds rate needs to be and that upper bound could be closer to 7%.

A federal funds rate of 7%? That’s a mighty jump from the current range of 3.75% to 4.00% and seems rather alarmist. But Bullard is continuing the Fed’s unofficial strategy of talking tough whenever the stock and bond markets seem to be getting euphoric. The result: Stock and bond markets yawned and took it mostly in stride, with bond yields inching — but only inching — higher this morning.

All of this led to the 1 p.m. close of the reopening auction of CUSIP 91282CEZ0, creating a 9-year, 8-month Treasury Inflation-Protected Security. This TIPS, which trades on the secondary market, closed Wednesday with a real yield of 1.37%. But Bullard’s comments appeared to give investors some caution, pushing the auctioned high yield up to 1.485%. The bid-to-cover ratio was a mediocre 2.25, indicating fairly weak demand.

Because the auctioned real yield was much higher than the coupon rate of 0.625%, investors got this TIPS at a discount, with an adjusted price of about $94.29 for about $102.15 of principal, after accrued inflation is added in. This TIPS will have an inflation index of 1.02147 on the settlement date of Nov. 30.

For today’s investors, all is good. The real yield of 1.485% was the highest for any 9- to 10-year TIPS auction since April 2010, when a 9-year, 9-month TIPS got a real yield of 1.709%. For anyone counting, there have been 75 TIPS auctions of this term since April 2010. Today was a milestone.

Real yields have been climbing throughout 2022, a trend that escalated in March once the Federal Reserve committed to increasing interest rates and cutting its balance sheet in the face of 40-year-high U.S. inflation. Here is the year-to-date trend in 10-year real yields:

Inflation breakeven rate

At the auction’s close at 1 p.m. ET, the nominal 10-year Treasury note was yielding 3.77%, giving CUSIP 91282CEZ0 an inflation breakeven rate of 2.29%, the lowest for this term since an auction in July 2021. That’s an attractive rate, in my opinion, making this TIPS a decent bet versus a 10-year Treasury. If inflation averages more then 2.29% over the next 10 years, this TIPS will out-perform. Inflation over the last 10 years, ending in October, has averaged 2.6%.

Here is the year-to-date trend in the 10-year inflation breakeven rate, showing how inflation expectations have been trending downward as the Federal Reserve maintains its hawkish posture:

Reaction to the auction

The overall TIPS market had been trading lower all morning, indicating higher yields, as shown in the one-day chart for the TIP ETF, which holds a broad range of maturities. This chart is all about the statements by Fed president James Bullard, and the auction result had almost no effect on TIPS prices.

So, investors at today’s auction got a gift from Bullard, amounting to an 11-basis point increase in real yield over the next 9-years, 8 months. Getting the highest real yield in 12+ years looks like a solid investment.

Today’s auction closes the books on CUSIP 91282CEZ0, a TIPS that transitioned the 10-year market from remnants of the easy money days of 2021 to the tighter policies of 2022. Its coupon rate of 0.625% — which now looks low — was the highest for any TIPS of this term since May 2019. A new 10-year TIPS will be auctioned on Jan. 19, 2023.

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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. The investments he discusses can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Have we passed the peak for real yields? Or is this another head-fake?

By David Enna, Tipswatch.com

Well, that was a wild week. Look back to Nov. 3, when both 5- and 10-year TIPS real yields were closing in on 12-year highs, with the 5-year at 1.82% and the 10-year at 1.74%, based on U.S. Treasury estimates. Then came Thursday’s October inflation report, and everything changed.

October inflation came in well below expectations, only the second downside surprise in more than a year. Annual all-items inflation was running at 7.7%, below estimates of 8.0%, and core inflation came in at 6.3%, below estimates of 6.6%. Both the stock and bond markets took this as a signal the Federal Reserve can soon begin easing future interest rate increases. The S&P 500 soared nearly 6.5% in the next two days. The U.S. bond market — represented by the AGG ETF — rose about 2.1% in a single day (the bond market was closed Friday in honor of Veterans Day).

For bonds, higher prices equal lower yields. And real yields on Treasury Inflation-Protected Securities moved substantially lower from Nov. 3 to Nov. 10, according to Treasury estimates:

• The 5-year real yield fell from 1.82% to 1.48%, a drop of 35 basis points.
• The 10-year real yield fell from 1.74% to 1.43%, a fall of 31 basis points.
• The 30-year real yield fell from 1.76% to 1.58%, a drop of 18 basis points.

And now, on Thursday, the Treasury will offer $15 billion in a reopening auction of CUSIP 91282CEZ0, creating a 9-year, 8-month TIPS. At this point, although real yields are down, this TIPS still looks attractive. But we are entering a week of high uncertainty.

A look at CUSIP 91282CEZ0

Update: 10-year TIPS reopening auction gets real yield of 1.485%, highest in more than 12 years

I’ve been a fan of this TIPS, buying a small amount at the originating auction on July 21, which produced a real yield of maturity of 0.630% and set the coupon rate at 0.625%. At the time, that was the highest coupon for a new TIPS in three years. Then I bought a larger amount in the first reopening on Sept. 22, which boosted the real yield to 1.248%, the highest in more than 12 years.

CUSIP 91282CEZ0 trades on the secondary market, and at the week’s close it had a real yield of 1.40% and a price of $92.98 for $100 of value, according to Bloomberg’s Current Yields page. That quote may include some international trading on Friday, because it is a bit below the Wall Street Journal‘s Thursday real yield estimate of 1.432%.

Definition: The “real yield” of a TIPS is its yield above official future U.S. inflation, over the term of the TIPS. So a real yield of 1.40% means an investment in this TIPS will exceed U.S. inflation by 1.40% for 9 years, 8 months. If inflation averages 2.5%, you’d get a nominal return of 3.9%, pretty much on par with a nominal U.S. Treasury. But if inflation averages 4.5%, you’d get a nominal return of 5.9%.

So let’s go with the real yield of 1.40% and price of $92.98, which is below par value because the real yield is currently well above the coupon rate of 0.625%. This TIPS will carry an inflation index of 1.02147 on the settlement date of Nov. 30. That means investors will be paying about $94.98 for $102.15 of accrued value, plus maybe 23 cents more for accrued interest.

An investor buying $10,000 in par value of this TIPS will pay about $9,521 for about $10,215 in accrued value plus $23 in accrued interest. That is a rough estimate and things can change before Thursday.

It’s still attractive. While we might have been dreaming two weeks ago of 10-year real yields reaching 2.0% or higher, a yield in the range of 1.40% is still attractive, at least in view of the past decade of ultra-low interest rates. It would be the highest real yield for any 9- to 10-year TIPS auction since April 2010, when a 10-year TIPS reopening auction got a real yield of 1.709%.

Here is the trend in the 10-year real yield over the last 12 years, showing that current yields remain at decade-old highs:

• Confused by TIPS? Read my Q&A on TIPS

• Upcoming schedule of TIPS auctions

Inflation breakeven rate

With the nominal 10-year Treasury note now yielding 3.81%, a 10-year TIPS with a real yield of 1.40% gets an inflation breakeven rate of 2.41%, in line with recent auction results. Inflation expectations have been falling in recent months, as the Federal Reserve shows resolve in fighting inflation with higher interest rates and balance sheet reductions. At this point, with U.S. inflation running at 7.7% annually, this breakeven rate looks reasonable.

Here is the trend in the 10-year inflation breakeven rate over the last 12 years, showing that the current rate remains at the top end of the historical range, but below the surge to nearly 3.0% in April 2022, just as the Federal Reserve was beginning to tighten:

Thoughts on this auction

Have we hit a top in the trend of higher real yields? Or was last week’s volatility just another head-fake in a year of bond market fluctuations? Personal opinion: It’s hard for me to resist this auction, since I have bought this same TIPS twice at lower real yields. On the other hand, have I already bought enough TIPS maturing in 2032? Should I look elsewhere? Should I wait until January’s auction of a new-issue 10-year TIPS, when real yields could be even lower? (Or not.)

Each investor will need to find answers to those questions. My general feeling throughout 2022 has been to load up on TIPS while real yields are attractive. My fear: This might not last long. Then again, maybe we have entered a “new era” in the U.S. bond market? Uncertainty.

As an alternative to this 10-year TIPS auction, I have considered going to the secondary market to buy TIPS maturing in 2030 and 2031, two holes in my TIPS ladder caused by the ultra-low yields of the 2020 to 2021 era. Those TIPS also had deep declines in yields after the October inflation report:

I checked on Fidelity’s trading platform Saturday morning and prices were slightly higher than Thursday’s close, but I can’t view prices for smaller lots. (Vanguard’s platform no longer lists any of these, not sure why.) There’s no way to know what we will see Monday, but if the real yields on these remain higher than the current yield of CUSIP 91282CEZ0 I might head in this direction to fill gaps in my TIPS ladder. Then I would look to fill the 2033 slot in January.

I still view this reopening of CUSIP 91282CEZ0 as a solid investment, despite the dip in yields. If you are considering investing, make sure to watch Bloomberg’s Current Yields page for real-time updates on its yield and price. 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 the results soon after the auction closes at 1 p.m. ET Thursday.

Here is a history of 9- to 10-year TIPS auctions back to 2018, when the Federal Reserve launched its last tightening cycle, lasting until early 2020. Note that one year ago, on Nov. 18, 2021, a 10-year TIPS reopening got a real yield of -1.145%, the lowest in history for this term.

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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. The investments he discusses can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.