New 10-year TIPS gets real yield of 0.630% at auction, a nice result for investors

Posted on July 21, 2022 by Tipswatch

A weak bid-to-cover ratio of 2.18 indicates lousy demand from big-money investors.

By David Enna, Tipswatch.com

The Treasury’s offering of $17 billion in a new 10-year Treasury Inflation-Protected Security — CUSIP 91282CEZ0 — generated a real yield to maturity of 0.630% at auction Thursday, the highest yield at auction for this term in two years.

The coupon rate was set at 0.625%, the highest coupon for a new TIPS in three years. In fact, this auction broke a string of 15 consecutive auctions of 9- to 10-year TIPS with a coupon rate of 0.125%, the lowest the Treasury will go for a TIPS.

Definition: The “real yield” of a TIPS is its yield above or below official future U.S. inflation, over the term of the TIPS. So a real yield of 0.630% means an investment in this TIPS will exceed U.S. inflation by 0.630% for 10 years.

Investors in today’s auction should be pleased, because a surprise rate hike this morning by the European Central Bank had set both nominal and real yields sliding lower. Nothing drastic, but for much of the morning it looked like this auction’s real yield might dip below 0.60%. The bid-to-cover ratio was 2.18, a very low number and an indication that weak demand forced the real yield higher.

Because the Treasury set the coupon rate at 0.625%, slightly below the auctioned yield, investors paid an unadjusted price of about $99.95 for $100 of par value. However, because this TIPS will have an inflation index of 1.00495 on the settlement date of July 29, the adjusted price was about $100.45 for $100.49 of value, after the inflation accrual is added in.

Here is the trend in 10-year real yields in 2022, showing the strong surge higher since the Federal Reserve committed to future rate hikes in March, in an effort to slow soaring U.S. inflation:

Inflation breakeven rate

With a 10-year nominal Treasury trading today with a yield of 2.96%, this TIPS gets an inflation breakeven rate of 2.33%, which looks like an attractive number. It means this TIPS will out-perform a nominal Treasury if inflation averages higher than 2.33% over the next 10 years.

U.S. inflation is currently running at an annual rate of 9.1%. While that number is expected to begin falling in future months, most experts agree it is likely to remain in the 4% to 5% range well into 2023, maybe higher. So again, this auction looks like a positive result for investors.

Here is the trend in the 10-year inflation breakeven rate through 2022, showing how inflation expectations have been falling in reaction to the Federal Reserve’s commitment to fight inflation:

Reaction to this auction

I was a buyer at today’s auction, so I was keeping my eye on TIPS trends through the morning. The European Central Bank’s surprise rate hike (the first in more than 10 years) did appear to roil the bond market, but the moves weren’t dramatic. One effect of the rate hike could be a stronger Euro and weaker dollar, which could slightly elevate inflation in the U.S., but also boost profits of U.S. corporations doing business in Europe.

It’s possible big money investors decided to sit this auction out, especially as real yields appeared to be declining through the morning. Bloomberg’s report noted that demand was “soft” at this auction. The bid-to-cover ratio of 2.18 indicates weak demand, which forced the Treasury to accept a higher real yield. But as shown in this chart for the TIP ETF, the market reacted to the auction’s close at 1 p.m. with a yawn. Nothing to see here.

But for buyers at today’s auction, a real yield of 0.630% and a price very close to par is a welcome result. Keep in mind that principal balances for this TIPS will rise 1.37% in August, based on non-seasonally adjusted inflation in June 2022. That’s a darn good first month. (And as a side note, I will point out that the nominal 10-year German bond is currently yielding 1.22% annually, less that the upcoming one-month inflation accrual for this TIPS.)

Today’s auction of CUSIP 91282CEZ0 is the first of three for this issue. It will reopened at auctions in September and November. I think there is a reasonable chance yields will be higher at those future auctions, but a lot will depend on the state of the U.S. economy and the Federal Reserve’s commitment to fighting inflation.

Here is a chart of all 9- to 10-year TIPS auctions going back to January 2019, the last auction before the Fed abandoned its tightening policy that began, very slowly, in 2015:

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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.

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 Investing in TIPS | 18 Comments

This week’s 10-year TIPS auction has ‘potential’

Posted on July 17, 2022 by Tipswatch

But beware: Real yields are volatile; even hour to hour

By David Enna, Tipswatch.com

Update, July 21: New 10-year TIPS gets real yield of 0.630% at auction, a nice result for investors

The Treasury on Thursday will auction $17 billion in a new 10-year TIPS, CUSIP 91282CEZ0, and this offering should be somewhat historic, for several reasons:

  • That $17 billion number is the highest auction amount in history for a 10-year TIPS opening or reopening. The last auction of a new 10-year, on January 20, was for $16 billion. A year before, on Jan. 21, 2021, the size was $15 billion.
  • So the amount is increasing even as the Federal Reserve is reducing its balance sheet of TIPS and other Treasurys, meaning it won’t be rolling over its current holdings. The Treasury is trusting that investor demand will pick up the slack.
  • The Treasury on Friday estimated the real yield of a 10-year TIPS at 0.57%, which would be the highest real yield at auction for this term since an auction on March 20, 2020, in the midst of pandemic panic.
  • Unfortunately, that Treasury estimate has fallen 15 basis points in the last week. This is the sort of volatility we are seeing in the Treasury market, every week, as the market reacts to potential Fed actions to combat inflation.
  • If the auctioned real yield holds above 0.50%, the coupon rate for this TIPS will be set at 0.50%, or possibly even 0.625% if the real yield can break through to 0.625% or higher. A coupon rate of 0.50% would be highest for a new TIPS since an auction on Jan. 17, 2019.

Watching market coverage this week, I was catching the drift from “experts” that the Fed will raise short-term interest rates, probably 75 basis points, later this month and then again — possibly 50 basis points? — in September and then go quiet, waiting to see how the economy reacts. The current Federal Funds Rate is in the range of 1.50% to 1.75%, but effectively 1.75%. An increase of 75 basis points brings it to 2.50% and another 50 to 3.00%.

At this point, short-term Treasury bills are already pricing for those increases, with the 13-week Treasury yielding 2.37% and the 1 year at 3.12%. But beyond those short-term rates, the yield curve goes flat, with the 5-year Treasury note at 3.05%, the 10 year at 2.93% and the 30 year at 3.10%. That’s not good news for investors in a 10-year TIPS, because lower nominal yields will drag real yields lower, most of the time.

All this could change next week, as the bond market slushes around based on the latest “theory” of the Fed’s future actions and the effects on the U.S. economy. Inflation expectations have also been sliding lower, even after last week’s dreary June inflation report, which set annual U.S. inflation at 9.1%.

Definition: The “real yield” of a TIPS is its yield above or below official future U.S. inflation, over the term of the TIPS. So a real yield of 0.57% means an investment in this TIPS will exceed U.S. inflation by 0.57% for 10 years.

I tend to believe that if inflation continues at a pace around 4% to 5%, which seems likely for many months, real yields will have to rise as the Fed continues stepping on the brakes. So is a 10-year TIPS yielding 0.57% attractive? I’d say yes, even knowing future rates could be higher. Here is a history of the 10-year real yield from 2010 to today:

Note that we have now reached the mid-point of 10-year real yields during the Fed’s last tightening cycle, which peaked in late 2018. At that time, the 10-year real yield rose to about 1.15%. Also at that time, U.S. inflation was running at 2.2%, far below today’s 9.1%. The Fed has a long way to go before it can end the current tightening cycle.

Pricing. If the real yield of this TIPS holds above 0.50%, the coupon rate will be 0.50% and the unadjusted price should be a little less than par value. However, this brand new TIPS will have an inflation index of 1.00495 on the settlement date of July 29. Why? Because non-seasonally adjusted inflation ran at 1.1% in May, so the half-month inflation accrual for this TIPS is 0.49% on the settlement date.

The inflation accrual means that investors could be paying an adjusted price of about $100.49 for about $100.49 of value, with accrued inflation. But the price will be a bit lower because the real yield will end up being higher than the coupon rate. It could balance out, but will probably be a bit above $100.00.

Inflation breakeven rate

With a 10-year Treasury note yielding 2.93% at Friday’s close, this new TIPS would have an inflation breakeven rate of 2.36%, which seems very attractive given current conditions. I’d prefer to invest in a TIPS with a yield exceeding inflation by 0.57%, versus a straight nominal yield of 2.93%.

Here is the trend in the 10-year inflation breakeven rate from 2010 to 2022:

In this chart, note that the current inflation breakeven rate of 2.36% is 20 basis points below the rate in March 2013, when annual inflation was running at a paltry 1.5%. Markets can be weird.

The recent decline in the 10-year inflation breakeven rate indicates that real yields have been holding up better than nominal yields. It also seems to indicate fairly weak demand for TIPS right now. That could be a factor in Thursday’s auction, with the Treasury issuing a record-high $17 billion in a 10-year TIPS.

Conclusion

The dip in real yields last week is a negative for investors, but I’d still be very interested in this TIPS if the real yield can hold above 0.50%. If the economy seriously weakens, we have to be prepared for the Fed to attempt a rescue, as it has continuously done over the last 20+ years. This TIPS isn’t attractive enough to “bet the house,” but a sensible investment seems fine to me.

You can check the Treasury’s real yield estimates for a full-term 10-year TIPS on its Real Yield Curve page. This auction closes at noon Thursday for non-competitive bids, like those made at TreasuryDirect. 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 report the results after the auction closes at 1 p.m. EDT Thursday.

Here is a recent history of 9- to 10-year TIPS auctions, showing the long string of negative real yields in the aftermath of the pandemic outbreak, beginning in March 2020:

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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.

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 Investing in TIPS | 49 Comments

Social Security COLA looks likely to rise about 10% for 2023

Posted on July 15, 2022 by Tipswatch

Want to understand how the COLA is calculated? It’s complicated. Read on …

By David Enna, Tipswatch.com

With the release of the June inflation report on Wednesday, we now have a pretty good idea of where the Social Security cost-of-living adjustment will be heading for payments in 2023, beginning with benefits received in January.

Inflation trends through June make it look likely that next year’s COLA could fall into a range of 9.6% to 10.3% for 2023, the highest increase since an 11.2% bump in 1981. But if inflation continues at its current torrid pace, the COLA could be even higher.

The Social Security Administration’s COLA formula is ridiculously complex and little understood. Is it related to U.S. inflation? Yes, but not the inflation index you hear about each month. Does it reflect 12 months of U.S. inflation? Not really. Does it underestimate actual U.S. inflation? Sometimes, but not always.

Annual U.S. inflation (measured by CPI-U) is running at 9.1% as of June, but the Social Security Administration doesn’t use CPI-U. Instead, it uses the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). For that index, the June annual increase was actually higher, at 9.8%.

The Senior Citizens League, a credible advocacy group, is projecting that the 2023 COLA could be 10.5%, and I think that is possible, but also might be just a tad too high. Why the uncertainty? The SSA’s complex formula makes predictions extremely iffy and airtight accuracy is impossible. Let’s take a look at how the COLA comes together …

The Index

CPI-W includes data only from households with at least 50% of income coming from clerical or wage-paying jobs. I’ve noted in the past that CPI-W generally lags slightly behind CPI-U, which means the Social Security COLA also generally lags behind the standard measure of U.S. inflation. However, this year — and also last year — it has running higher than official inflation.

CPI-W isn’t widely tracked or reported, but the Bureau of Labor Statistics updates the index each month in its overall inflation report. Right now, you could say, “Well, CPI-W is running at an annual rate of 9.8%, so that will likely be the COLA increase for 2023.” But that’s not true. In fact, the June number isn’t necessarily an accurate indicator, as shown in this chart:

June sets the baseline for the COLA increase, but then we come to …

The Formula

The SSA doesn’t look at a full year’s data to determine the COLA. Instead it uses the average CPI-W index for the third quarter — July, August and September. Here is the definition from the SSA site, in typical crystal-clear language of government bureaucrats:

A COLA effective for December of the current year is equal to the percentage increase (if any) in the average CPI-W for the third quarter of the current year over the average for the third quarter of the last year in which a COLA became effective. If there is an increase, it must be rounded to the nearest tenth of one percent. If there is no increase, or if the rounded increase is zero, there is no COLA.

The translation: This wording means that the SSA eliminates years where inflation was zero or negative, and so there isn’t a “bounce-up” effect on benefits after a year of deflation. Instead, it goes back to the last year where there was an increase in benefits. But that won’t matter in this 2023 calculation, because the COLA rose 5.9% this year.

So, although 12-month CPI-W was up 9.8% in June, that number is only the baseline for the 2023 COLA increase. The only inflation numbers that will matter are for the third quarter: July, August and September. Last year, the CPI-W index averaged 268.421 in the third quarter. The June 2022 index was set at 292.542, which is 9.0% higher than the 3rd quarter average in 2021. So if we have zero inflation in July, August and September, the Social Security COLA will be set at 9.0%.

U.S. inflation can be stubbornly finicky in the summer months, so predicting inflation from July to September is an impossible task. Hurricanes, gas shortages, food crop failures, stock market plunges, outbreaks of war, supply shortages, pandemic resurgence, etc., etc. It’s a guessing game, and nearly every summer brings some surprises.

Plus … the U.S. economy could potentially be slowing, which could at least tame our current raging inflation, a bit.

Projecting the 2022 COLA

At this point, CPI-W is running at 9.8% over the last year, so maybe you’d expect a continued inflationary trend of nearly 0.8% through the summer months? It could happen. I don’t think it will, however. The Cleveland Fed is currently projecting an all-items inflation rate of 0.39% for July, which I’m sure is influenced by the recent decline in gas prices.

If gas prices continue slipping lower this summer — and that’s a big if, I know — then inflation should begin moderating, while staying at very high level. Could inflation run at 0.0% for three months? Doesn’t seem likely. But what about 0.4% or 0.5% a month? That seems possible. Plus, we could see an oddball month, surprisingly higher or lower. It happens almost every summer.

Let’s take a look at how differences in 3rd-quarter inflation would alter the 2023 COLA:

Where is inflation heading this summer? I really don’t know. I can tell you that last year — when inflation was beginning to percolate — CPI-W rose from 266.412 in June to 269.086 in September, an increase of 1.0%. But that 1% increase was front-loaded into a 0.52% increase in July, followed by relatively tame increases of 0.22% in August and 0.26% in September.

Inflation is hard to predict

Yeah, but I write about inflation, so why not take a stab? My thinking is that inflation is likely to average 0.3% to 0.6% a month from July to September, and that would put the Social Security COLA in a range of 9.6% to 10.3%. If current inflationary trends continue, I’ll probably end up on the low side.

So let’s nail this down to a prediction of 9.9% to 10.1%. (But I’m queasy about this.)

In 2021, I predicted a COLA increase of 6.0% “looks likely.” Correct answer: 5.9%.

In 2020, I predicted “a number very close to zero,” Correct answer: 1.3%.

In 2019, I predicted “a range of 1.6% to 1.8%.” Correct answer: 1.6%.

In 2018, I predicted a range of 3.1% to 3.2%. Correct answer: 2.8%.

In 2017, I predicted the COLA was likely to be “less than 2.2%.” Correct answer: 2.0%

So there you go, that’s my track record. The point is: You will be seeing lots of media reports in coming weeks about the Social Security COLA soaring to 10% or higher. But no one truly knows. Three months of data are needed. At least now you can understand how those predictions were made, and the complex formula that underlies the whole thing.

What this all means

For 2022, the Social Security Administration says, the average monthly benefit for retired workers is $1,666, so a 10% increase would boost that benefit to $1,833, beginning in January. If you are in the Social Security “limbo” period — older than 62 but not yet taking benefits — your future benefits would also climb by this percentage.

However, recipients can also expect that Medicare Part B costs could rise in 2023, which will subtract — at least partly — from the higher benefits. But this is a foggy issue, because the SSA pushed Part B charges 14.6% higher for 2022 because of potential approval of the Alzheimer’s drug, Aduhelm. Since then, the costs of that drug have declined, and it is not being widely used. That could mean Part B charges won’t increase greatly in 2023, or possibly even decline.

We won’t know the actual COLA number until 8:30 a.m. EDT on October 13, 2022, when the Bureau of Labor Statistics releases the September inflation report and completes the data needed for the 3rd quarter average of CPI-W. I will be tracking these numbers for July, August and September as each inflation report is issued.

I keep a running total of the CPI-W changes on my Social Security COLA page.

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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.

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 Retirement, Social Security | 8 Comments

June inflation hits new highs: 1.3% for the month, 9.1% year over year

Posted on July 13, 2022 by Tipswatch

Annual inflation is now running at the hottest pace since 1981.

By David Enna, Tipswatch.com

Have we hit peak inflation yet? The answer is: we don’t know, because the June inflation report showed inflation surging ever higher, greatly exceeding already lofty expectations.

The Consumer Price Index for All Urban Consumers increased 1.3% in June on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 9.1%, the largest 12-month increase since November 1981. These results were much higher than economist expectations, which called for 1.1% for the month and 8.8% year over year.

Core inflation, which eliminates food and energy, also exceeded expectations, rising a disturbing 0.7% for the month (versus a consensus of 0.5%) and 5.9% year over year (versus an expected 5.8%). This surge in core inflation indicates the broad-based nature of U.S. inflation, which looks likely to continue running hot even if gas prices start falling.

The BLS noted that June price increases struck “almost all major component indexes.” Some highlights:

  • Food at home costs increased 1.0% for the month, after rising 1.4% in May, and are now up 12.2% year over year. The dairy index rose 1.7% in the month, following a 2.9% increase in May. The sole food group to show a decline was meats and poultry, falling 0.4% in the month.
  • Gasoline prices surged 11.2% in June, and were up 59.9% over the last year. This trend seems to have reversed in July, with gas prices falling a bit throughout the month, so far.
  • The overall energy index rose 41.6% over the last year, the largest 12-month increase since the period ending April 1980.
  • Shelter costs increased 0.6% in June and are up 5.6% for the year.
  • The rent index rose 0.8% over the month, the largest monthly increase since April 1986.
  • Prices for used cars and trucks continued climbing, up 1.6% for the month.
  • Apparel prices surged 0.8% for the month and are up 5.2% for year.
  • The medical care index rose 0.7% in June, and is up 4.8% for the year.
  • Airline fares fell 1.8% in June after increasing strongly over recent months.

My overall impression is that, yes, U.S. inflation may have peaked in June because we could see gasoline prices begin to fall the rest of the summer. But clearly, even if the annual inflation rate begins to inch down from 9.1%, prices will continue to rise across the economy. Don’t be fooled by any claim in coming months that “inflation is under control.”

Here is the 12-month trend for both all-items and core inflation, showing that core inflation has started to stabilize at close to 6%, an unacceptably high rate:

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 all TIPS and set future interest rates for I Bonds. For June, the BLS set the inflation index at 296.311, an increase of 1.37% over the May number.

For TIPS. The June inflation index means that principal balances for all TIPS will increase 1.37% in August, after rising 1.1% in July. For the year ending in August, inflation accruals will have totaled 9.1%. Here are the new August Inflation Indexes for all TIPS.

For I Bonds. The June inflation report is the third in a six-month string — March to September — that will determine the I Bond’s new variable rate, which will be reset November 1. After three months, inflation has increased 3.06%, which would translate to a variable rate of 6.12%. But three months remain, and a lot can happen in three months, especially summer months when inflation is very hard to predict. The I Bond’s current variable rate is 9.62%.

Here are the numbers so far:

What this means for the Social Security COLA

The June inflation report sets a baseline figure for next year’s cost-of-living adjustment for Social Security, but the Social Security Administration uses a different index, Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). For June, CPI-W was set at 292.542, a year-over-year increase of 9.8%.

Does that mean Social Security benefits will increase 9.8% in January? No. the SSA uses the average of CPI-W over the months of July, August and September to determine the next year’s increase. Last year’s three-month average was 268.421, so at this point the increase would be 9.0%. That’s not a projection, because inflation should continue rising through the summer. But it is a starting point. I will be tracking these numbers on my Social Security COLA page.

What this means for future interest rates

I suspect that the Federal Reserve was prepared for this rather disturbing June inflation report, and will move forward with plans to increase short-term interest rates 75 basis points at it July 26-27 meeting, and then possibly again in September.

As we have seen in recent weeks, the Fed can move short-term rates higher, but has no real control over longer-term rates, which have been declining on recession fears. The nominal yield curve has flattened, with the 1-year Treasury trading at 3.18%, the 2-year at 3.18%, the 5-year at 3.11% and the 10-year at 3.02%.

Real yields on TIPS have been holding up nicely, with the 5-year now at 0.53% and the 10-year at 0.65%. I am thinking next week’s auction of a new 10-year TIPS will be a decent buying opportunity.

I wouldn’t be surprised if inflation moderates in the next few months, but continues at a historically high range. The economy is likely to weaken, and the Fed will be under pressure to “declare victory” and stop the rate hikes.

My conclusion: Take advantage of attractive short-term rates (about 2.2% on a 13-week Treasury) and continue to lock in attractive real yields on TIPS. Yes, rates are likely to go higher, but there is always the threat of the Fed backing off and intervening in a weakening economy. We’ve seen it before.

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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.

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 I Bond, Inflation, Investing in TIPS, Social Security | 42 Comments

A 10-year TIPS is maturing Friday. How did it do as an investment?

Posted on July 10, 2022 by Tipswatch

Despite a real yield deeply negative to inflation, CUSIP 912828TE0 out-performed a nominal 10-year Treasury.

By David Enna, Tipswatch.com

Back on July 19, 2012, the U.S. Treasury auctioned a new 10-year TIPS, CUSIP 912828TE0, with a rather dire result: The real yield to maturity was -0.637%, which at the time was a record low for any TIPS auction of this term. The coupon rate was set at 0.125%, and buyers paid a hefty premium of about $107.84 for $100 of par value.

In July 2012 U.S. inflation was running at 1.4% and investors weren’t very interested in inflation protection, as noted in this Wall Street Journal report after the auction:

The $15 billion auction of 10-year Treasury Inflation Protected Securities, or TIPS, garnered mediocre interest given the negative-0.637% yield that was offered in a time of little inflationary threat. That’s the lowest yield the government has had to deliver in its sales of 10-year TIPS. It drew a bid-to-cover ratio of 2.62, the lowest measure of overall demand since September.

So, this was a hopeless investment, right? Not exactly. When you compare this TIPS to a nominal 10-year Treasury note available in July 2012, it turns out that — against the odds — CUSIP 912828TE0 ended up out-performing the nominal Treasury.

CUSIP 912828TE0 will mature on July 15, 2022, with an inflation index of 1.26346, meaning that a $10,000 investment at the original auction (which would have cost about $10,784 because of the premium price) will be returning $12,635 to the investor, along with that 0.125% annual coupon rate on the growing principal balance.

That’s a return of about $2,000 over 10 years on a $10,000 investment., or an annual percentage return of about 1.85%. Not stellar. But at the time, a 10-year nominal Treasury was yielding only 1.54% and would have returned only about $11,658 after 10 years, even if you figure in compounding.

So CUSIP 912828TE0 ended up being a “winning” investment, despite its deeply negative real yield to maturity. It auctioned with an inflation breakeven rate of 2.18%, and 10 years later, inflation has averaged 2.4% a year.

The big picture

Up until a year ago, TIPS had been under-performing nominal Treasurys for most of the last decade because inflation was running much lower than expectations. Obviously, with U.S. inflation currently running at 8.6%, we have turned the corner on that. Will that trend continue? It seems very likely, for awhile at least.

Here is how 10-year TIPS have performed versus 10-year Treasury notes for all maturities since July 2013:

Notes and qualifications

This chart is an estimate of performance, because it uses a full month of inflation in the beginning and ending months, when actually TIPS accruals are based on a half month for the first and last months, with the origination and maturity occurring on the 15th of the month.

Keep in mind that interest on a nominal Treasury and the TIPS coupon rate is paid out as current-year income and not reinvested. So in the case of a nominal Treasury, the interest earned could be reinvested elsewhere, which would potentially boost the gain. For certain, we don’t know what the investor could have earned precisely on an investment after re-investments.

In the case of a TIPS, the inflation adjustment compounds over time, and that will give TIPS a slight boost in return that isn’t reflected in the “average inflation” numbers presented in the chart.

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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.

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 Inflation, Investing in TIPS | 7 Comments