Podcast: ‘The Inflation Guy’ analyzes the February inflation report

Posted on March 12, 2022 by Tipswatch

“This 7.9% rate is a jumping off point for what March will bring us.”

Tipswatch.com

As expected, U.S. inflation continued at a four-decade high in February, and things are likely to get worse with the spike in commodity and transport costs in March. Buy gas lately? Or food? Ouch.

What does it all mean? Where is inflation heading? Let’s get some answers from inflation guru Michael Ashton and his “Cents and Sensibility” podcast. I am a fan of this podcast and Ashton’s work because he has deep knowledge of how inflation works, but can explain complex issues in an entertaining way.

In this episode, Ashton asks:

  • How relevant are food and gas prices in the overall inflation picture? Why do these basic costs get excluded from “core inflation”? Won’t they eventually force wages to rise?
  • Is inflation likely to peak soon?
  • Why is it unlikely that the Federal Reserve will act decisively to drive down soaring inflation?
  • What is the pace of likely Federal Reserve rate increases?

Here is his podcast intro: “Another month, another 40+-year high in inflation. 7.9% y/y for headline, 6.4% on core, and we’re not yet at the peak. Moreover, the peak is likely to be broader and not sharp, because inflation has infected the whole basket and changed the equilibrium that we are going to recede to. It’s as if a juggler has moved from juggling two balls to juggling five; that is a stable equilibrium and will resist moving back. And the Fed is probably going to be careful before upsetting the juggler too much (the Inflation Guy really had to work hard to resist a balls pun).“

Have a listen:

Direct URL: https://inflationguy.podbean.com/e/ep-22-this-month-s-cpi-report-balls-in-the-air/

Who is Michael Ashton?

His audiences know him as the “Inflation Guy.” He is a pioneer in the U.S. inflation derivatives market. Before founding his company, Enduring Investments, Ashton worked in research, sales and trading for several large investment banks including Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003, when he traded the first interbank U.S. CPI swaps, and 2004 when he was the lead market maker for the CME’s CPI Futures contract, he has played an integral role in developing new instruments and methods for accessing and hedging various inflation exposures. In 2016, Mr. Ashton published What’s Wrong With Money? The Biggest Bubble of All. He is a graduate of Trinity University and lives in Morristown, New Jersey.

Have a question? Get the Inflation Guy app in the Apple App Store or Google Play, or email InflationGuy@enduringinvestments.com.

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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 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 | 9 Comments

U.S. inflation soared 0.8% in February, hitting annual rate of 7.9%, highest in 41 years

Posted on March 10, 2022 by Tipswatch

Inflation continues at a four-decade high, with costs of shelter, food and gasoline surging.

By David Enna, Tipswatch.com

The numbers are ugly, but today’s inflation report mostly matched economist expectations, despite hitting a 41-year high.

The Consumer Price Index for All Urban Consumers increased 0.8% in February on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported. Over the last 12 months, the all-items index increased 7.9%. The monthly number slightly exceeded expectations, but the year-over-year number matched predictions.

Annual U.S. inflation of 7.9% is the highest for any year ending in February since 1981, when inflation soared to 11.4%.

Core inflation, which eliminates food and energy, rose 0.5% in February and is up 6.4% year-over-year. Both these numbers matched expectations.

The BLS noted that increases in the costs many American staples — gasoline, shelter, food and apparel — led the way on price increases. This is a high-pain event. Here are some of the data:

  • Gasoline prices increased 6.6% for the month and are up 38% over the last year. Remember, this is the February number, and does not factor in strong increases so far in March. The BLS said gas prices accounted for almost a third of the overall gain in monthly inflation.
  • The food at home index increased 1.4% and is up 8.6% over the last year.
  • The index for fruits and vegetables rose 2.3%, its largest monthly increase since March 2010.
  • The index for meats, poultry, fish, and eggs increased 1.2% in February.
  • Shelter costs rose 0.5% in February and are up 4.7% for the year. The BLS said shelter costs accounted for more than 40% of the increase in core inflation. This was the largest 12-month increase in the shelter index since May 1991.
  • Apparel costs were up 0.7% in February, after rising 1.1% in both December and January.
  • On the positive side, the costs of medical care services rose only 0.1%, and prices of medical care commodities were up a moderate 0.3%.
  • Also, prices for used cars and trucks, which had been soaring, fell 0.2% in the month but remain 41.2% higher year over year. Costs for new vehicles rose 0.3%.

Side note: I did a search for the word “largest” in the BLS news release, and I found the document contained that word 12 times, across a broad spectrum of price categories. These are history-making numbers, and March will probably get worse with the sudden, steep surge in gas prices.

Here is the one-year trend for all-items and core inflation, showing the incredible surge higher. Hard to believe that annual inflation in February 2021 was running at a mundane 1.7%.

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 TIPS principal balances and set future interest rates for I Bonds. For February, the BLS set the inflation index at 283.716, an increase of 0.91% over the January number.

For TIPS. The February inflation report means that principal balances for all TIPS will be increasing 0.91% in April, following an 0.84% increase in March. For the year ending in April, principal balances will have increased 7.9%, a remarkable — and let’s admit it, unexpected — surge higher. Remember, the reason for investing in TIPS is to protect against “unexpectedly” high inflation. That strategy is working.

Here are the new April Inflation Indexes for all TIPS.

For I Bonds. The February report is the fifth of a six-month string that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on May 1 for all I Bonds. So far, inflation from September 2021 to February 2022 has been running at 3.43%, which translates to a variable rate of 6.86%. One month remains, and March inflation is likely to be quite high. It’s easy to see the possibility of a variable rate exceeding 8% — or even 9% — at the May reset, higher than the current rate of 7.12%.

One factor to consider, however: Non-seasonally adjusted inflation increased 0.71% in March 2021, setting up a rather high number for March 2022 to beat. Gasoline prices rose 9.1% in March 2021 over February 2021. That will lessen the effect of this year’s sudden surge, but only in the year-over-year number. Clearly, gasoline prices have increased in March 2022 over February 2022, and that will push up the March monthly number.

If, for example, non-seasonally adjusted inflation rises 0.9% in March — definitely possible — then the six-month inflation number would be 4.33%, creating a variable rate of 8.66%. If it hits 1.0%, the variable rate would rise to 8.86%.

Does that mean you should wait until after May 1 to invest in I Bonds, which have a purchase cap of $10,000 per person per year? Absolutely not. If you buy an I Bond before May 1, you will earn an annualized 7.12% for a full six months, and then the new variable rate for the next six months. Buying before May 1 — in my opinion — is the way to go.

Here are the numbers so far, which I track on my “Inflation and I Bonds” page:

What this means for future interest rates

While the February inflation report could reasonably be called “shocking,” increases of this level were clearly predicted and should not have much effect on the Federal Reserve’s near-term actions. But I believe the market turmoil caused by the war in Ukraine and surging gas prices will cause the Fed to go the moderate route in raising short-term interest rates.

I think the Fed will raise its federal funds rate by 25 basis points next week, and then continue with 25-basis-point increases at points through the year and next year, eventually hitting a target of 1.50% to 1.75%, up from current level of 0.0% to 0.25%. That’s a total of five rate increases, but who knows.

The March inflation report will be ugly, reflecting the spike higher in gasoline prices and related transportation costs. The threat of recession is at least “looming,” and that should hold down longer-term interest rates as the yield curve flattens. After March, inflation could begin sliding lower, but nowhere near the Fed’s target of about 2.25%.

This insight is from inflation guru Michael Ashton, @inflation_guy on Twitter:

“So wrapping up: there’s no real sign of any ebbing of inflation pressures. In fact, there are some signs that food inflation will stay elevated for longer than the normal oscillation cycle. But we are closer to the end of the spike, anyway, than to the beginning. …

“Core inflation will likely peak next month, and headline inflation in the next couple of months. That’s good. But we’re not going to go back to 2%. Right now, the monthly prints point to an underlying core rate around 6%. I suspect we will end 2022 in the 5s, or high 4s.”

Right now, the only very predictable thing is “uncertainty.”

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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 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 | 22 Comments

Should the Treasury raise the I Bond purchase cap to $100,000?

Posted on February 22, 2022 by Tipswatch

An op-ed piece in today’s Wall Street Journal makes the case.

By David Enna, Tipswatch.com

Probably the most-often-mentioned “negative” of the U.S. Series I Savings Bond is the purchase cap of $10,000 per person per calendar year, plus the option of $5,000 in paper I Bonds in lieu of a federal tax refund. A lot of investors look at that limit and brush the attractive investment aside as “insignificant.”

And that’s true if you are sitting on a multi-million-dollar portfolio and looking to make a one-time investment in I Bonds. That $10,000 or even $15,000 will barely budge your asset allocation.

That’s why I have argued for years that the Treasury’s purchase cap requires an investor to buy I Bonds year after year, up to the cap if possible, to build a sizeable allocation in inflation protection. This strategy means buying even if the fixed rate is 0.0% and the inflation-adjusted variable rate is 0.16%, as we saw through six months of 2016. (Those 2016 I Bonds will be paying 7.12% annualized this year for six months, just like the “very attractive” I Bonds you can purchase today.)

I Bonds are getting a lot of attention right now, thanks to that 7.12% annualized rate, which is likely to remain quite high throughout 2022 and into 2023. According to the Wall Street Journal, over the past three months I Bond purchases have soared to $7.1 billion, compared with an average of $700 million a year during the decade before.

But, here’s the question: Should the Treasury raise the purchase cap? Absolutely.

When I Bonds were first created in the fall of 1998, the purchase limit was $30,000 per person per year, and the Treasury even allowed credit cards to be used for purchases with no fees. (Air miles!) However, according to Finweb.com, the Treasury determined about 98% of all savings bonds were purchased in amounts under $5,000. This triggered a new policy in 2008: a $5,000 limit per calendar year.

The current limit of $10,000 per person per calendar year went into effect in January 2012, when the Treasury required I Bonds to be purchased in electronic form at TreasuryDirect, except for the $5,000 option as a tax refund. So the current cap has been in effect for a decade, with no adjustments for inflation over that time. It takes $12,400 in today’s dollars to match the buying power of $10,000 in January 2012.

So yes, the Treasury should immediately raise the purchase cap on I Bonds to allow Americans to protect more of their savings from surging inflation. I’ve suggested doubling the amount to $20,000 per year (or $40,000 for a couple). And maybe at the same time eliminate the $5,000 tax refund option, which is probably a logistical nightmare for the IRS and Treasury.

A much more dramatic proposal

The Wall Street Journal today carried an op-ed piece by Joshua Rauh (a senior fellow at Stanford University’s Hoover Institution) and Kevin Warsh (a former member of the Federal Reserve Board and visiting fellow at Hoover). They argue that surging inflation is becoming a “menace” that requires decisive action:

“President Biden, by executive order, should immediately direct Treasury Secretary Janet Yellen to raise the annual cap on Series I savings bonds from $10,000 to $100,000. … The executive order should also make clear that the higher purchase cap would fall when price stability is re-established, as certified by the Fed. …

“If the revamped I-bond program grew in popularity, the government would accrue higher funding costs. That’s part of the point. The government should internalize the budgetary and reputational costs of its policy errors. … Inflation’s 40-year hiatus from history is over. Errant monetary and fiscal policy decisions are to blame.”

Clearly, this proposal has a strong political spin, but it is hard to disagree with the theory that excessive monetary policy (by the Federal Reserve) and fiscal policy (by Congress) have sent inflation surging to a 40-year high.

My initial thought, however, is that raising the purchase limit to $100,000 temporarily would be a financial windfall for more wealthy Americans, allowing a couple to sock away $200,000 earning 7.12% interest as a short-term investment. Would these wealthy investors jump into — and then out of — I Bonds when yields fall in the future? Very likely.

I’d prefer to see the I Bond purchase limit increase to $20,000 per person per year permanently, and then be indexed to inflation (possibly in $500 increments). Or … even better … raise the limit to $30,000 as it was when the I Bond launched in 1998. (Can we also use credit cards for purchases with no fees? OK … let’s not get greedy.)

If you want to know more about how I Bonds work as investment, check out these pages on my site:

I Bond Manifesto: Using I Bonds as part of your emergency fund

Q&A on I Bonds: The way I Bonds work

Inflation and I Bonds: Tracking the I Bond’s variable rate

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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 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, Savings Bond | 56 Comments

New 30-year TIPS auctions with a real yield of 0.195% to seemingly weak demand

Posted on February 17, 2022 by Tipswatch

By David Enna, Tipswatch.com

Despite a flight to safety sending yields downward in the Treasury market, a new 30-year Treasury Inflation Protected Security auctioned Thursday with a higher-than-expected real yield to maturity of 0.195%, the first positive real yield for any TIPS at auction in nearly two years.

This is CUSIP 912810TE8, which received a coupon rate of 0.125% based on the auction results. So today’s investors got another thing they haven’t seen in nearly two years: A TIPS auctioning with a discounted price, because the real yield to maturity was higher than the coupon rate. The adjusted price was about $98.10 for about $100.14 of value, after accrued inflation is added in. This TIPS will have an inflation index of 1.00142 on the settlement date of February 28.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match current U.S. inflation. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above inflation.

The last time a TIPS auction of any term got a positive real yield was for a 10-year reopening auction on March 19, 2020, amid a day of near-complete market chaos because of pandemic fears. A few days later, the Federal Reserve launched an aggressive campaign to stabilize the Treasury market, sending real yields deeply negative.

While the market had been signaling that this new TIPS would get a positive real yield, the auction result was still a surprise. At 11:10 a.m. EST, a 29-year, 6-months TIPS was trading on the secondary market with a real yield to maturity of 0.10%. After the auction’s close, that yield increased to 0.18%, a pretty impressive move higher.

Obviously, investors in this new issue wanted higher-than-market yields, and the auction delivered. The bid to cover ratio was 2.17%, a low number that also indicates weak demand.

Here is the trend in 30-year real yields over the last 11 years, dating back to before an earlier phase of Federal Reserve quantitative easing, which began in spring 2011:

This chart might tell us where real yields could be heading in coming years. Note how in 2013 30-year real yields surged higher, because the Fed raised the possibility of tapering its bond-buying program, which didn’t actually begin until early 2014. Yields began declining in 2019, as the Fed started easing off on tightening.

The difference in 2022 is that the Fed is signaling an accelerated schedule: It could begin raising short-term interest rates and gradually reducing its balance sheet within a month. In that scenario, real yields should be climbing higher, and that was probably the message the market was sending today.

Inflation breakeven rate

With a 30-year nominal Treasury trading today with a yield of 2.30%, this new TIPS gets an inflation breakeven rate of 2.11%, on a par with recent auctions of this term. Clearly, investors are not foreseeing unusually high inflation over the next three decades, despite the current surge to 7.5% in January 2022.

For investors in today’s auction, an inflation breakeven rate of 2.11% looks like a positive. Here is the trend in the 30-year inflation breakeven rate over the last 11 years:

While the 30-year inflation breakeven rate surged strongly after March 2020, with the beginning of aggressive economic stimulus by Congress and the Federal Reserve, it has now settled into a “normal range” based on historical standards.

Reaction to the auction

The TIP ETF — which holds the full range of TIPS maturities — had been trading higher all morning, indicating lower real yields. But after the auction’s close at 1 p.m. EST, prices quickly dipped, indicating a negative reaction to the auction. Since then, however, the TIP ETF has stabilized.

Investors saw a similar reaction in LTPZ, Pimco’s 15+ Year U.S. TIPS ETF. Two minutes before the auction’s close, it was trading at $80.98 a share, but four minutes later had fallen to $79.68, a drop of 1.6% in the blink of an eye.

A 30-year TIPS isn’t a highly desirable investment for small-scale investors, Non-competitive bids amounted to only $14 million of the total of $9 billion auctioned Thursday. So today’s auction showed that the market’s big money — hedge funds, pensions funds, sovereign banks — are looking for higher yields. That could be continuing trend.

The Bloomberg report on the auction theorized that a “hawkish shift by the Federal Reserve is dashing demand for inflation-indexed Treasuries.”

The auction went begging “because when the Fed hikes, their primary goal is to move long-end real rates higher,” said Gang Hu, managing partner at Winshore Capital Partners LP. “Yes, we have moved them higher by a fair amount, but to be long them is to fight the Fed.”

CUSIP 912810TE8 will be reopened at auction in August. Here’s a recent history of TIPS auctions with 29- to 30-year terms:

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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 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 | 10 Comments

30-year TIPS auction could break through negative real-yield barrier

Posted on February 13, 2022 by Tipswatch

The Treasury will offer $9 billion in a new 30-year TIPS at auction Thursday. Here’s what to expect.

By David Enna, Tipswatch.com

It’s been two years since we’ve seen any TIPS auction, of any term, generate a real yield to maturity higher than zero. But that could change Thursday, when the Treasury auctions $9 billion in a new 30-year Treasury Inflation-Protected Security, CUSIP 912810TE8.

The coupon rate and real yield to maturity will be set by the auction, which closes at 1 p.m. EST Thursday. But we can get a pretty good idea where this auction is heading: The coupon rate will almost certainly be set at 0.125%, the lowest the Treasury will go for any TIPS. And the real yield to maturity has a decent chance of rising above zero, making this the first TIPS auction since February 2020 to get a positive real yield.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above inflation.

The U.S. Treasury issues an estimate of the real yield of a full-term 30-year TIPS each day after the market closes. On Friday, this estimate was 0.09%, up 45 basis points since the beginning of the year. A lot could change over the next week (for example, in the Ukraine), but for now, it looks like this auction has a good chance of generating a positive real yield, meaning a yield that will exceed official U.S. inflation over the next 30 years.

Here is the trend in the 30-year real yield over the last two years, a period that began before the pandemic-caused market panic of March 2020 and continued through two years of aggressive economic stimulus by both Congress and the Federal Reserve:

In recent months, as the Federal Reserve has indicated it will end its bond-buying quantitative easing in March, 30-year real yields have been rising steadily, but still remain below pre-pandemic levels. My opinion is that a “normalized” 30-year real yield would be in the range of 1.0% to 1.5%, and even that is low by historical standards. So these long-term real yields have room to rise, if the economy remains strong and the Federal Reserve begins reducing its massive balance sheet of Treasurys.

However, if the U.S. economy shows any sign of weakness, I’d expect long-term real yields to be depressed by a flattening yield curve. But they should still be positive, offering a return above inflation.

Even if it gets a yield positive to inflation, CUSIP 912810TE8 could still end up auctioning with a slight premium price, because the real yield will still be below the coupon rate of 0.125%. Most likely, that premium will be about 1% above par, if the real yield holds at 0.09%. However, this TIPS will carry an inflation index of 1.00142 on the settlement date of Feb. 28. This means investors could end up paying about $101.14 for about $100.14 of value, after accrued inflation is added in. That’s a rough estimate!

Inflation breakeven rate

With a 30-year Treasury bond trading at 2.24% at the market close Friday, a new 30-year TIPS would have an inflation breakeven rate of 2.15%, which seems reasonable. That means this TIPS would outperform a nominal 30-year Treasury if inflation averages more than 2.15% over the next 30 years.

An inflation breakeven rate of 2.15% is in line with 30-year TIPS auctions back in 2017 and 2018, when U.S. inflation was running at about 2.0%. Now that number is a much-more threatening 7.5%. But the financial markets don’t seem worried, and don’t this trend continuing over 30 years. In fact, markets are predicting inflation at a very moderate rate. We’ll see.

Here is the trend in the 30-year inflation breakeven rate over the last 2 years, showing that long-term inflation expectations have stabilized and even declined slightly over the last year:

Thoughts on this auction

I’ve made it clear for years that I am not a fan of 30-year TIPS with real yields this low. This is a highly volatile investment, and a move of 50+ basis points higher, as we have seen in just the last three months, can reduce the market value of a 30-year TIPS by 15%. For example, a 30-year TIPS reopening auction last August had a premium price of about 12.8% above par value, or $112.84 for $100 of value. Today that same TIPS has a market value of $101.50, meaning it has lost more than 10% of its value in just six months.

Of course, volatility can work both ways, and if you are interested in trading TIPS as a speculative investment, a 30-year TIPS can be attractive. Otherwise, the very long term and high volatility make it unattractive for me. Just my opinion.

30-year TIPS versus a 30-year I Bond

So, if this new 30-year TIPS gets a real yield to maturity slightly higher than zero, does it become more attractive than a U.S. Series I Bond, with a fixed rate of 0.0%? I’d say no. I Bonds have several key advantages over a TIPS:

  • The holding term of an I Bond is flexible, anywhere from 1 year (with a three-month interest penalty), to 5-plus years with no penalty, all the way to 30 years when they reach final maturity.
  • An I Bond will never go down in value during a time of deflation, while a TIPS will lose accrued principal during deflationary times.
  • Interest earned on an I Bond can be deferred until it is sold or matures. For TIPS, both the coupon payment and inflation accruals are taxable in the current year. This “phantom income” makes a 30-year TIPS very unattractive for holding in a taxable account.
  • I Bonds have an advantage in the way their interest is compounded, since it all gets compounded. With a TIPS, the coupon rate is paid out as current income and is therefore not compounded (but could be reinvested elsewhere).

My feeling is that I Bonds — at this point — remain more attractive than any TIPS of any maturity. My view would change if we see real yields on 5- and 10-year TIPS climb well above zero. But at this point, I Bonds up to the purchase limit of $10,000 per person per year should be your first money invested in inflation protection.

Auction details

Thursday’s auction will close to non-competitive bids — like those made at TreasuryDirect — at noon EST and then finalize at 1 p.m. EST. If you are purchasing this TIPS in a brokerage account, be aware than auction purchases might be closed by 10 a.m. the day of the auction, or even earlier.

I will be reporting the auction results soon after the close. Here’s a listing of recent 29- to 30-year TIPS auctions, showing that the string of three consecutive negative yields is actually an aberration for this term, even during earlier times of Federal Reserve quantitative easing:

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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 purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in I Bond, Investing in TIPS | 2 Comments