Treasury Inflation-Protected Securities

What’s up with those crazy real yields on ultra-short-term TIPS?

Posted on September 2, 2022 by Tipswatch

By David Enna, Tipswatch.com

Update: This TIPS matured Jan. 15, 2023. How did it work as an investment?

Just about every month, I get emails or comments from readers pointing out what appears to be extremely attractive real yields on very short-term TIPS — especially those maturing in less than a year. My usual response is that these real yields get highly exaggerated as maturity nears and only one coupon payment remains.

I’ll admit I don’t fully understand the mechanics of the quoted real yields when TIPS are down to the final months. But I assume — and I am pretty sure I am right — that the market is pricing these TIPS correctly. This month, we have another example, and I decided to take a walk-through look at this possible investment, CUSIP 912828UH1:

CUSIP 912828UH1 was originally issued as a 10-year TIPS on January 15, 2013. I wrote about this TIPS back then, believe it or not. It was in the early years of misery for TIPS investors, with this TIPS getting a real yield of -0.630% and a coupon rate of 0.125%. Now, as it is approaching maturity, it has built up an inflation accrual index of 1.28372 as of September 1. And on Thursday it was trading with an “apparent” real yield of 4.047%, according to the Wall Street Journal’s closing statistics.

So, an investor in this TIPS will be purchasing 28.3% of additional principal above par, and that principal is not protected against deflation in future months. In fact, the principal balance of this TIPS will decline 0.01% in September, based on non-seasonally adjusted inflation in July. We could see more declines in October and November, if falling gas prices create deflationary numbers for August and September, which seems possible.

I went onto Vanguard’s trading platform and entered a $10,000 purchase of this TIPS (for example purposes only — I didn’t complete the purchase). Here is what the order sheet showed Thursday afternoon:

Note that a purchase of $10,000 of par value will cost an investor $12,660.82. Here’s a rundown on the basics of that investment, and note that my total cost is off from Vanguard’s by 5 cents, and I have no idea why:

Because of the discounted price, an investor is getting $12,837 of principal from a $12,661 investment, which is attractive. But just how attractive? It’s hard to say, because the final payment at maturity on January 15, 2023, is going to depend on how hot or cold inflation runs through November. The Treasury market is speculating that inflation will decline or at least remain muted through the end of the year, which could be accurate. Or could this be recency bias based on the recent collapse in oil prices?

Here is my speculation on a “muted inflation” scenario for this TIPS, with inflation falling -0.05% in August, then remaining flat in September, rising 0.1% in October and then 0.2% November. (This TIPS will get an inflation adjustment of 15 days from November inflation in its final month.)

If things work out this way — pure speculation — the investor on September 1 will have invested $12,660 and will get a return of about $12,863 on January 15.That’s a gain of $203, which isn’t shabby for a 4 1/2 month investment. It’s an annualized return of about 4.38%. Not quite up to I Bond standards, but better than similar nominal Treasury yields, which are hanging just above 3%.

Based on this rough look at CUSIP 912828UH1, it seems like a reasonable investment, given the discounted price. The investor picks up the risk of the 28% inflation accrual, which could get depleted if deflation becomes a “thing” in the next several months. My example may be too optimistic. Who knows? The market is clearly signaling a belief that inflation will be very low, or negative, through November.

Would I buy it? No, I am not interested. It’s just too complex to be worth the trouble. This example was simply meant to demonstrate the “logic” of today’s market, which might be logical, or possibly crazed.

* * *

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 | 17 Comments

Yes, I am still traveling (and news is breaking out all over the place)

Posted on August 28, 2022 by Tipswatch

By David Enna, Tipswatch.com

I woke up today in rainy Sitka, Alaska. Rain is not an an unusual thing in Alaska in August, I have learned. It has rained every single day on this trip, which started August 14. Rain is in the forecast for the rest of the trip.

But hey, we’ve seen some rainbows … and bears, moose, eagles, ravens, caribou, reindeer … along the way. No otters yet, I want to see an otter.

I know a lot of news has been breaking out in the last two weeks, which always seems to happen when I am traveling, especially in places with little or no internet. From the little I can grasp, it appears that Fed Chairman Jerome Powell finally set the markets straight on his intentions: To fight inflation until inflation is defeated. That was what Powell should have said, and the markets should have expected it.

But, no, the markets still had a lingering belief that the Fed would step in to save the stock market. But that can’t happen while U.S. inflation is continuing at an annual rate of 8.5% and raging even higher across the globe.

So for inflation-protected investments, what has happened in the last two weeks?

The 5-year real yield started at 0.29% on Aug. 15 and closed Friday at 0.47%.
The 10-year real yield started at 0.35% and ended at 0.47%.
The 30-year real yield started at 0.89% and ended at 0.85%.

These aren’t dramatic moves, but the current yields keep the 5- and 10-year TIPS as attractive investment possibilities. There’s a 10-year TIPS reopening auction coming up on Sept. 22, followed by a new 5-year auction on Oct. 20. Both of these could be attractive, especially since the 5-year real yield should track higher with any upcoming Fed moves in September.

I’m not connected enough right now to give an opinion on anything else going on. If you you have ideas, comments or theories, post them in the comments section below.

I will be back home in North Carolina mid-week, as long as I survive whatever Covid protocols are thrown at me in the last days of the trip. In closing, here’s a view of Denali National Park:

* * *

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.

Posted in Investing in TIPS | 27 Comments

30-year TIPS reopening gets a real yield of 0.92%

Posted on August 18, 2022 by Tipswatch

By David Enna, Tipswatch.com

The U.S. Treasury’s reopening auction today of CUSIP 912810TE8 — creating a 29-year, 6-month Treasury Inflation-Protected Security — got a real yield to maturity of 0.92%. This was the highest yield for any auction of this term in more than 2 years.

It looks like the auction was met with strong demand, with the real yield coming in a few basis points lower than where this TIPS was trading right before the auction’s close. The bid-to-cover ratio was 2.69, also an indication of good demand.

This TIPS had an originating auction in February, where it got a real yield of 0.195% and a coupon rate of 0.125%. Thursday’s auction demonstrates how much real yields have surged higher in 2022. Investors paid an adjusted price of about $84.61 for about $106.40 of principal, after accrued inflation is added in. This TIPS will have an inflation ratio of 1.06397 on the settlement date of Aug. 31.

The inflation breakeven rate, by my estimate, was 2.21%.

I am traveling this week and I am about to go on a trek into Alaska’s Denali National Park, so I will just close with the usual graphs … Real yields, inflation breakeven rate, and auction history.

* * *

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.

Posted in Investing in TIPS | 5 Comments

30-year TIPS reopening auction is coming Thursday. Any takers?

Posted on August 14, 2022 by Tipswatch

By David Enna, Tipswatch.com

A 30-year Treasury Inflation-Protected Security is a potentially volatile investment. probably most appropriate for big-money investors like insurance companies, hedge funds and central banks. The term of 30 years makes it a tough purchase as part of a hold-to-maturity bond ladder, and the volatility creates uncertainty most small-scale investors don’t need.

The Treasury on Thursday will auction $8 billion in a reopening of CUSIP 912810TE8, creating a 29-year, 6-month TIPS. To give you an idea of this term’s volatility, consider this:

CUSIP 912810TE8 was created at an originating auction on Feb. 17, 2022, with a real yield to maturity of 0.195%, which set its coupon rate at 0.125%. The unadjusted price was about $97.96 for $100 of par value. It sold at a discount because the auctioned real yield was higher than the coupon rate.
This TIPS is now trading on the secondary market and closed Friday with a real yield of 0.90% and a price of about $80 for $100 of par value.
So do the math: In just six months, this TIPS has declined in value by 18%.

However … today’s real yield of about 0.90% is a heck of a lot more appealing than February’s 0.195%. Is it enough to make this offering attractive? Not for me, but it could be for anyone who speculates that real yields will be heading deeply lower in future months.

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 0.90% means an investment in this TIPS will exceed U.S. inflation by 0.90% for 29 years, 6 months.

Here is the trend in the 30-year real yield over the last three years, showing the strong rise from the never-seen-before 30-year negative real yields triggered by the Fed’s aggressive market intervention after the Covid outbreak in March 2020:

So, yes, a real yield of 0.90% looks pretty attractive. But you don’t have to go back far into TIPS history to find higher 30-year real yields. As recently as February 2019, a 30-year TIPS originating auction got a real yield of 1.093% and a much more attractive coupon rate of 1.0%. But 0.9% isn’t bad by recent standards. You have to go all the way back to February 2011 to find a 30-year TIPS auction with a real yield higher than 2%.

Because CUSIP 912810TE8 has a coupon rate of 0.125%, it is an extremely inappropriate investment to hold in a taxable account (like any purchase at TreasuryDirect). If you bought $10,000 of this TIPS, you would earn $12.50 in the first year from the coupon rate, while potentially owing current-year taxes on an inflation accrual that could top $600 or more in year one. If you are in the 24% tax bracket, this TIPS would potentially be cash-flow negative by $150 or more every year for as long as you held it. Do not buy this TIPS in a taxable account.

Another thing to consider is that this TIPS will carry an inflation index of 1.06387 on the settlement date of Aug. 31. That will ramp up your cost, but also increase your accrued inflation. The adjusted price could end up around $85.12 for $106.40 of accrued value. That is a rough estimate and things could change this week. (Plus there will be a very small amount of accrued interest, about 57 cents on a $10,000 investment).

That means a $10,000 par investment at Thursday’s auction will cost about $8,512 for about $10,640 of accrued principal. For people who worry about severe deflation in coming years, that $640 is not guaranteed to be returned at maturity. However, the chance of that happening is essentially zero.

Inflation breakeven rate

With a 30-year Treasury bond closing Friday with a nominal yield of 3.11%, this TIPS currently has an inflation breakeven rate of 2.21%, which seems in line with historical standards. The market is not forecasting steeply higher inflation over the next three decades. I think that reasonable rate makes this TIPS more appealing than a 30-year nominal Treasury.

Here is the trend in the 30-year inflation breakeven rate over the last three years, showing that inflation expectations have settled down in recent months as the Federal Reserve began raising interest rates and lowering its balance sheet of Treasury holdings:

Thoughts on this auction

If you are reading this article, thank you. Not many people are interested in a 30-year TIPS. The term is too long and the investment is too volatile for small-scale investors. I’ve purchased two TIPS of this term in my investing history, both in a taxable TreasuryDirect account:

CUSIP 912810FH6 back in April 1999, with coupon rate of 3.875% and a real yield to maturity of 3.899%. Yes, I still hold it and this TIPS will have earned about 12.4% over the year ending in September. Its current inflation index will be 1.80245 on September 1.
CUSIP 912810QP6 in February 2011, just a month before I launched this Tipswatch site. It carries a coupon rate of 2.125% and so it will have earned about 10.6% for the year ending in September.

When CUSIP 912810QP6 matures, I will be 87 years old. I might make it! But any 30-year TIPS I buy today won’t mature until 2052. Prediction: I won’t make it. So the 30-year term falls out of my investing scope. If you are younger, and you want to put a small amount of CUSIP 912810TE8 on the top rung of your TIPS ladder, I can endorse the strategy. Just don’t do it in a taxable account.

You can check the Treasury’s real yield estimates for a full-term 30-year TIPS on its Real Yield Curve page and also see how CUSIP 912810TE8 is trading in real time on Bloomberg’s Current Yields 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’m traveling again

By the time this TIPS auction closes at 1 p.m. EDT Thursday, I will be traveling somewhere in south-central Alaska. I will attempt to post the auction results, but that will depend on if I have internet access and free time. I will also to try check in to answer questions, if you have any.

In the meantime, here is a history of every 9- to 10-year TIPS auction going back to 2015:

* * *

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.

Posted in Investing in TIPS | 13 Comments

U.S. inflation went flat in July: What it means for I Bonds, TIPS and Social Security COLA

Posted on August 10, 2022 by Tipswatch

Core inflation continues at 5.9%, an unsustainable rate.

By David Enna, Tipswatch.com

I warned you: Inflation numbers are notoriously fickle in the summer months, and so here we go: All-items U.S. inflation increased 0.0% in July on a seasonally adjusted basis, the Bureau of Labor Statistics reported today. The year-over-year number dipped to 8.5%, down from June’s 41-year-high of 9.1%.

Inflation was expected to dip in July because of a strong drop in gasoline prices, a trend that continues in August. But today’s inflation numbers were well below the consensus estimates of 0.2% for all-items and 8.7% for the annual rate. Core inflation, which removes food and energy, came in at 0.3% for the month and 5.9% for the year, also below consensus estimates.

For American consumers, this is good news. We seem to have finally passed “peak inflation” and prices are heading down. But keep in mind that annual inflation is still running at 8.5%, a dangerously high number.

The BLS noted that gasoline prices fell 7.7% in July, after increasing 11.2% in June, and still remain 44% higher than a year ago. The decline in gas prices helped offset a 1.3% increase in the cost of food at home, now up a painful 13.1% over the last year. June was the seventh consecutive month where food prices increased 0.9% or more.

Other notable trends:

Shelter costs increased 0.5% in July and are up 5.7% year over year. The rent index rose 0.7% in July. The BLS said shelter costs accounted for about 40% of the increase in core inflation.
Costs for used cars and trucks dipped 0.4%, but are still up 6.6% over last year’s highly elevated prices.
Prices for new vehicles increased 0.6% and are up 10.4% for the year.
The index for natural gas declined in July after sharp recent increases, falling 3.6%. (Let me know when you see your natural gas bill decline in response.)
The medical care index rose 0.4% in July after rising 0.7% in June, and is now up 5.1% year over year.
The index for airline fares fell sharply in July, decreasing 7.8%.

So, while overall inflation was down in July, the complete picture remains complex. Gas prices down, food prices up and everything else … mostly up, with core inflation continuing to run at 5.9%. Here is the 12-month trend for all-item and core inflation, showing that while overall inflation seems to have peaked, core inflation appears locked in at around 6.0%:

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 of TIPS and set future interest rates for I Bonds. For July, the BLS set the CPI-U index at 296.276, down 0.01% from June’s number of 296.311.

For TIPS. July’s inflation report means that principal balances for all TIPS will decline by 0.01% in September, after rising 1.1% in July and 1.37% in August. Over the year ending in September, TIPS principal balances will have increased 8.5%. Here are the new September Inflation Indexes for all TIPS.

For I Bonds. The July report is the fourth of a six-month string that will determine the I Bond’s new variable rate, which will be reset November 1. As of now, inflation has increased 3.05% in that four-month stretch, which would translate to a variable rate of 6.1%, very attractive but well below the current rate of 9.62%. Two months remain, and a lot can happen in two months. Stay tuned. Here are the numbers so far:

View historical numbers on my **Inflation and I Bonds** page.

What this means for the Social Security COLA

The July inflation report is the first of three — for July to September — that will set the Social Security Administration’s cost of living adjustment for 2023. The SSA uses a three-month average of a different index, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), to set its COLA.

For July, the BLS set CPI-W at 292.219, an increase of 9.1% over the last 12 months. However, CPI-W actually fell 0.1% for the month. But remember, it will be the average of July to September inflation indexes — compared to the same three-month average a year ago — that will determine the Social Security COLA. A year ago, that average was 268.421. July’s number was 8.9% higher. If we have zero inflation in August and September, the COLA will be 8.9%

In a recent article, I predicted that the 2023 COLA would get an increase of 9.9% to 10.1%. That could still happen, but the current trend in gas prices should push the number lower. We’ll see. Last year, July inflation ran fairly hot (about 0.5%) but then cooled off in August and September. Here are the historical numbers used in this COLA calculation:

View historical calculations on my **Social Security COLA** page.

And here is my updated projection for the Social Security COLA in 2023, factoring in the slight deflation in the July index:

What this means for interest rates

The Federal Reserve can’t steer away from its inflation-fighting course, but the July report gives it a little breathing room. It looks like year-over-year inflation has finally peaked. But notoriously volatile gas prices are the primary reason for the dip, and food prices continue to soar. It’s significant that for the first time in many months, inflation came in under consensus estimates. The stock market is happy, with the S&P 500 index already up about 1.6% at 9:35 a.m. EDT.

There should be no “declaring victory.” Inflation remains very close to a four-decade high and cannot continue even at the core rate of 5.9%. Reducing inflation will continue to be Job No. 1 for the Fed. Could we see a 50-basis-point increase in short-term rates in September, instead of 75? I think July’s inflation report made that more possible.

From this morning’s Wall Street Journal report:

Rapidly rising prices have become persistent following a surge in inflation from goods, energy and food, said Greg Daco, chief economist for EY-Parthenon, a consulting firm.

“That divergent trend shows there’s a breadth of inflation in that housing inflation and service-sector inflation remain elevated,” he said, adding price pressures in those areas could linger. “And those tend to be stickier than goods, which can and will start to reverse.” …

“Even if headline inflation slows on account of weaker energy prices but core inflation is stubbornly high, the Fed is likely to maintain its tightening bias as it will be concerned about high inflation being entrenched in consumer price expectations,” said Blerina Uruci, U.S. economist at T. Rowe Price Group Inc.

The inversion in nominal yields continues this morning, with the 26-week Treasury yielding 2.99%, the 2-year at 3.11% and the 10-year at 2.72%. The bond market is predicting economic weakness, which will make the Fed’s job even more difficult.

* * *

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.