Treasury Inflation-Protected Securities

U.S. inflation rose 0.1% in November, well below expectations

Posted on December 13, 2022 by Tipswatch

Stock and bond markets are celebrating, with good reason.

By David Enna, Tipswatch.com

For the second month in a row, U.S. inflation came in below expectations in November, clearing the way for speculation that the Federal Reserve could soon pivot away from interest rate increases in 2023.

The Consumer Price Index for All Urban Consumers rose just 0.1% in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 7.1%. Both of those numbers were below expectations of 0.3% for the month and 7.3% year over year.

Core inflation, which removes food and energy, also came in below expectations, rising 0.2% for the month and 6.0% for the year.

The all-items increase of 7.1% was the smallest 12-month increase since the period ending December 2021, the BLS said. The core increase of 6.0% was the smallest since August 2021.

Obviously, this inflation report will be greeted with joy in the stock and bond markets, providing a clear signal that the Federal Reserve can set a path toward less-aggressive monetary tightening. Just a few minutes ago, I heard a Bloomberg commentator suggest that we need to revive the “transitory” description for U.S. inflation. Uh … let’s not get ahead of ourselves.

The BLS noted that the cost of shelter (up 0.6% for the month and 7.1% for the year) was the biggest factor in all-items inflation, more than offsetting a 2.0% decline in the cost of gasoline (which is still up 10.1% year over year.). Other highlights from the report:

Food costs were up 0.5% for the month, continuing a string of sharply higher monthly price reports. Food at home costs are now up 12.0% year over year.
The index for fruits and vegetables increased 1.4% in November, after falling 0.9% in October. On the positive side, the index for meats and poultry fell 0.2% for the month.
Apparel costs were up 0.2% for the month and 3.6% for the year.
The costs of medical care services fell 0.7% for the month.
Costs for used cars and trucks fell for the fifth month in a row, down 2.9% for the month and 3.3% year over year (after rising sharply in 2021).
Costs of new vehicles held stable, but are up 7.2% year over year.
The index for airline fares fell 3.0% over the month, following a 1.1% decrease in October.

Overall, this was a positive inflation report, with the one exception of food prices, which are continuing to increase at a brisk pace. The cost of shelter, also higher, is considered a lagging indicator of past price increases rolling into effect. Shelter costs could eventually begin to fall in 2023.

Here is the trend in all-items and core inflation over the last 12-months, showing the consistent declines in all-items inflation since early summer, drawing closer to core inflation as gasoline prices have declined:

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 on I Bonds. For November, the BLS set the CPI-U inflation index at 297.711, down 0.1% from October.

For TIPS. The November report means that principal balances for all TIPS will decline 0.1% in January, after rising 0.41% in December. However, TIPS principal balances will have increased 7.1% for the year ending on January 31. Here are the new January inflation indexes for all TIPS.

Today’s report is sending real yields down sharply, which could affect the Dec. 22 reopening auction of CUSIP 91282CFR7, which two months ago auctioned with a real yield of 1.732%. This morning that TIPS is trading on the secondary market with a real yield of 1.27%.

For I Bonds. The November report is the second in a six-month string that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on May 1 based on inflation from October 2022 to March 2023. As of November, inflation is up 0.3%, which translates to an variable rate of. 0.60%. But it’s far too early to say where inflation is heading over the next four months. Here are the numbers:

View historical data back to 2012 on my Inflation and I Bonds page.

What this means for future interest rates

The U.S. stock market is set to open sharply higher in a few minutes, a predictable response to this inflation report. And in the bond market, yields are sharply lower. All of this is anticipating that weakening inflation will allow the Federal Reserve to gradually stall future increases in interest rates. I think the Fed will go ahead with a 50-basis-point increase tomorrow, but give dovish signals about future rate increases.

It’s impossible to say at this point that inflation has truly been “tamed,” but we will now be entering a phase where year-over-year comparisons should cause inflation to continue declining. In January 2022, non-seasonally adjusted inflation increased 0.84%; in February 2022, 0.91%; and in March 2022, 1.34%. It’s unlikely U.S. inflation in future months will match those numbers, so year-over-year inflation should continue to decline in early 2023.

The Federal Reserve appears to have a path ahead that will allow it to hold short-term interest rates near the level it announces tomorrow.

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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.

Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS | 22 Comments

Real yields have been slipping, but don’t lose heart

Posted on December 11, 2022 by Tipswatch

By David Enna, Tipswatch.com

Back in early November I worked with financial adviser (and overall economic guru) Allan Roth on an article he was writing for AARP. The topic: How surging real yields of Treasury Inflation-Protected Securities now made these investments more attractive than Series I Savings Bonds.

A month later, on Nov. 28, the article went live on the AAAP site, with the headline: “Today’s Best Inflation Buster: Treasury Inflation-Protected Securities“. Here is Roth’s main conclusion:

While the I Bond bought today gives you a 0.4 percent rate above inflation, that five-year TIPS mentioned earlier yields inflation plus 1.625 percent. That’s 1.23 percentage points in yield more than an I Bond. I … think TIPS are generally superior to I Bonds right now, since they provide a greater yield. But that could change at some point.

As Roth noted, “That could change.” And yes, things have changed in the short time since that article was published. The 5-year TIPS yield dropped as low as 1.16% on Dec. 2, a substantial decline from the 1.63% just a few days earlier in November. In recent days, the 5-year real yield has rebounded, closing Friday at 1.45%, based on Treasury estimates.

Yeah, we all had dreams of TIPS yielding 2.0%+ above inflation, but that doesn’t look likely anytime soon. (It still could happen, based on recent market volatility. One bad inflation report and … watch out.)

I believe TIPS yields remain attractive, while not spectacular, at these current levels. And there is no way to know how long this phase of high real yields will continue. If the U.S. economy goes sour, and inflation begins to wane, the Federal Reserve could again move to stimulate the economy. The result could be deeply lower yields.

Back on Nov. 20 when I wrote my article on I Bonds vs. TIPS I noted a “sense of urgency” in TIPS investing. Grab the good yields while they last. And I am still a buyer of TIPS at these yields.

Here is a chart of 5-, 10- and 30-year real yields over the last two years. Notice how yields began flattening when the Treasury began tightening in mid-2022. This is a typical reaction to tightening, as the market begins anticipating a slower economy, or possible recession. And even though real yields have declined a bit in the last month, they remain substantially higher than the market over the last decade.

Click on the image for a larger version.

January 2021 through March 2022 was an awful time to invest in TIPS, with yields substantially negative to inflation. December 2022 looks much more attractive in comparison.

It’s almost shocking to look at how TIPS yields have surged higher in just four months. Here is a chart showing TIPS and Treasury yields for 5- and 10-year terms, and the resulting inflation breakeven rates. As TIPS yields have been moving higher since August, the inflation breakeven rate has been declining. In other words, TIPS are now “on sale” versus similar nominal Treasurys. That’s a positive factor for TIPS investors. Here’s the chart:

In conclusion

Real yields have softened a bit from their highs in early November, triggered primarily by two “milder than expected” inflation reports, combined with vague pivot language from the Federal Reserve. But we can be certain that the Fed will raise short-term interest rates by 50 basis points at its meeting Dec. 13-14. A week later, on Dec. 22, the Treasury will auction a reopened 5-year TIPS.

If real yields hold at the current level of about 1.45%, I’d be a buyer of that 5-year TIPS, even though I’m loaded with 2027 maturities. I’d also be very likely to buy the new 10-year TIPS to be auctioned in January, filling a 2033 spot on my TIPS ladder.

That’s my plan. I’d love even higher yields, but I’ll take what I can get at this point in the tightening cycle. Remember, do your own research before investing.

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Posted in Federal Reserve, I Bond, Investing in TIPS | 43 Comments

My schedule … and what’s coming up

Posted on December 1, 2022 by Tipswatch

By David Enna, Tipswatch.com

View from our room near Alajuela, Costa Rica.

I’m traveling in Costa Rica for a couple weeks and I will often be in areas with weak or zero Internet connections. So I won’t be writing much and I may miss responding to some of your questions.

The holiday season is here but the news never stops. Fed Chairman Jerome Powell gave the stock and bond markets a boost Wednesday by suggesting that the December rate move by the Fed might be less aggressive. In other words, an increase of 50 basis points is coming. Just like everyone already knew. This was the Fed “signaling” the obvious. And of course the stock and bond markets are celebrating with a rally — stocks higher and bond yields lower.

On Dec. 13 at 8:30 a.m. EST the Bureau of Labor Statistics will release the November inflation report. I will be back at work that day, but I have no idea what to expect. The Cleveland Fed’s Inflation Nowcasting site is projecting an all-items increase of 0.47% for November and 7.49% year over year. But these Nowcasting predictions have been too high recently. We’ll see.

One day later, on Dec. 14, the Federal Reserve will announce its decision on the new federal funds rate. The obvious expectation is a 50-basis-point increase to a range of 4.25% to 4.50%. The Fed could be closing in on a “terminal” rate, but a lot will depend on future inflation reports and the status of the U.S. economy.

Then, a week later, on Dec. 22 at 1 p.m., the Treasury will close its auction of a reopening of CUSIP 91282CFR7, creating a 4-year, 10-month Treasury Inflation-Protected Security. This will be an interesting auction, coming a week after both the November inflation report and the Fed’s rate hike decision. Because this TIPS has a coupon rate of 1.625%, it’s possible it will be selling at a premium price. It is currently trading on the secondary market with a real yield of 1.29%, a stunning decline from the originating auction’s yield of 1.732% just six weeks ago. (And I’m just reminding everyone I called that October auction a unicorn — a rarely seen event. Looks like I might have been right.)

I will be posting a preview story on that TIPS auction on Sunday, Dec. 18, and posting the result on Dec. 22 after the auction closes.

Finally, on Jan. 1, 2023, the I Bond purchase calendar will reset and allow new purchases of up to $10,000 per person for that calendar year. Because the I Bond’s fixed rate is now 0.4% these savings bonds will remain attractive. I’ll be posting an I Bond buying guide for 2023 in early January.

Happy holidays and thanks for reading.

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Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS, Savings Bond | 10 Comments

I Bonds vs. TIPS: Right now, it’s clearly ‘advantage TIPS’

Posted on November 20, 2022 by Tipswatch

Despite the I Bond’s appeal, investors shouldn’t ignore the sizable yield advantage for TIPS.

By David Enna, Tipswatch.com

We’ve just gotten through a year of “I Bond mania,” which has brought a lot of welcome attention to a little-known, rarely discussed, but very safe and sensible investment. Now I have a news alert: I Bonds are no longer the star of the inflation-protected universe. That role has shifted to Treasury Inflation-Protected Securities, with real yields now hitting decade-plus highs.

I like both investments, and I will continue to buy both. But because of this year’s surge in real yields, TIPS have become much more desirable. Combine that with a sense of urgency, because there is no way to know how long this advantage will last. Here are the numbers from Friday’s market close:

I Bond: Current fixed rate of 0.4%, which equates to a real yield (above inflation) of 0.40%.
5-year TIPS: Current real yield of 1.71%, a yield advantage of 131 basis points over the I Bond.
10-year TIPS: Current real yield of 1.57%, a 117-basis-point advantage.
30-year TIPS: Current real yield of 1.63%, a 123-basis-point advantage.

Here is a chart showing how the advantage has shifted strongly to TIPS in the last half year:

Does this mean you should be rushing to sell your I Bonds to buy TIPS? Absolutely not. I Bonds have a key advantage over TIPS as a short-term investment, because their current interest rate is backwards-looking, based on past six-month inflation. The I Bond’s current inflation-adjusted variable rate is 6.48% annualized, for six months. That is too attractive to ditch.

For more on that, read this analysis: Short-term I Bond investors: Be patient with your exit strategy.

But as an investment you plan to buy and hold for 5 or more years, TIPS have a huge yield advantage over I Bonds. That shouldn’t be ignored. It is “normal” (historically, I mean) for the fixed rate of the I Bond to lag below the TIPS real yield. That’s okay, because I Bonds have a lot of other desirable features.

Advantages of I Bonds vs. TIPS

Both I Bonds and TIPS protect you against unexpected inflation. If inflation in the next 30 years suddenly soars to 7%, 10%, 15%, your principal will increase by that amount because of the inflation-adjusted interest rate for I Bonds or inflation accruals for TIPS.
I Bonds are a simple investment to buy and track, much simpler than a TIPS with a constantly changing market value and inflation accruals that update daily.
I Bonds accurately track U.S. inflation but can never go down a cent in value if we hit a period of deflation. This isn’t true for TIPS, which lose some principal value after every month of deflation.
I Bonds earn tax-deferred interest, while TIPS in a taxable account get hit by current taxes on both the coupon rate and the inflation adjustments in any year, even though the inflation accruals aren’t paid out until the TIPS matures or is sold.
I Bonds can be used tax-free to pay for educational expenses, under some circumstances.
I Bonds don’t trade on any secondary market and their value is never at risk if interest rates rise.
I Bonds allow you fantastic flexibility. You can redeem them after one year, costing you three months of interest. Or redeem them after five years and pay no penalty, or just hold them for 30 years and cash out.

Disadvantages of I Bonds vs. TIPS

As I noted above, I Bonds currently have a real yield well below the real yield of TIPS of all maturities.
I Bonds can’t be purchased in a tax-deferred account. This can make raising money for an I Bond purchase difficult, especially for retired people with no regular income. TIPS can be purchased in a tax-deferred brokerage account, so raising the money can be done without tax consequences.
I Bonds can’t be sold for a year, and there is a 3-month interest penalty for redemptions before 5 years. TIPS can be sold in the secondary market at any time, possibly at a loss or possibly at a gain.
In times of very low inflation, your 6-month annualized return for I Bonds can drop to a very low level, even 0.0%. But I Bonds in this case may outperform TIPS, which would lose principal value in that scenario.
Keep in mind, however, that even during times of deflation, a TIPS will continue to pay out its coupon rate. So a TIPS with a higher coupon rate has some added deflation protection. For example, the new TIPS issued in October has a coupon rate of 1.625%, so that is a buffer against annual deflation of at least 1.625%.
I Bond purchases are capped at $10,000 per person per year. TIPS purchases are essentially unlimited. It takes a lot of years of investing to build a sizable allocation in I Bonds. With TIPS, you can do that in a day.
I Bonds can only be purchased in electronic form at TreasuryDirect, a government site that has many critics. TIPS can be purchased at any major brokerage, often with zero commission and fees.
I Bonds can’t be sold on the secondary market, meaning there is no way to capture a capital gain if interest rates fall substantially. TIPS can be traded for gain or loss.
You cannot create a joint account at TreasuryDirect, so a couple would need to set up two accounts, one with I Bonds registered as Spouse 1 with Spouse 2, and the other, Spouse 2 with Spouse 1.

Why advantage TIPS?

We’ve gone through a decade-plus of extremely low interest rates, thanks to Federal Reserve interventions in the Treasury market. Real yields — meaning yields above inflation — were negative for much of this time. We have finally come out of this misery with a bang: Real yields for TIPS are now reaching levels we haven’t seen since 2008, in the case of the 5-year TIPS, and 2010 for the 10-year TIPS. At the same time, the market continues to price in fairly low future inflation, just 2.29% over the next 10 years, based on the last 10-year TIPS auction. That makes TIPS appealing versus nominal Treasurys.

I Bonds remain a great investment, in my opinion, and I will definitely be buying them up to the purchase limit in 2023. I Bonds are superior as a short-term investment of 1 to 2 years because of their backward-based interest rate and predictable return.

But TIPS right now are a superior longer-term investment, based solely on these historically attractive real yields. As I noted in a recent article, I was able to nab a 20-year TIPS with a real yield of 2.02% on the secondary market, and also filled 2030 and 2031 slots in my TIPS ladder with real yields just a bit over 1.5%. You can’t do this kind of investing with I Bonds, because of the $10,000 per person per year limit on purchases.

I imagine that a lot of I Bond faithful will disagree with my opinion, and I do understand that I Bonds are very attractive because of their simplicity, safety and rock-solid deflation protection. But TIPS are just a better investment in November 2022. Real yields of 1.5% are now available across the TIPS yield spectrum. Is that attractive? Just take a look at where we were a few months ago:

• 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 Bond Manifesto: How this investment can work as an emergency fund

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

• 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.

Posted in I Bond, Investing in TIPS, TreasuryDirect | 56 Comments

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

Posted on November 17, 2022 by Tipswatch

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.