This week’s 10-year TIPS reopening should get a positive real yield (finally!)

Posted on May 15, 2022 by Tipswatch

If the real yield holds above zero, this will be the most attractive TIPS auction in more than 2 years.

By David Enna, Tipswatch.com

Something great and unfortunately rarely seen could happen this Thursday, when the Treasury holds a $14 billion auction reopening CUSIP 91282CDX6, creating a 9-year, 8-month Treasury Inflation-Protected Security.

This reopened TIPS could 1) get a real yield positive to inflation, and 2) an auction price at a discount to par value. We haven’t seen either of these things for the last 12 TIPS auctions of this term, dating back to the wildly chaotic auction on March 19, 2020, when the financial markets were roiled by the pandemic outbreak.

CUSIP 91282CDX6 trades on the secondary market, and you can track its real yield to maturity and price on Bloomberg’s Current Yields page. As of Friday’s market close, it had a real yield of 0.18% and a price of $99.45 for $100 of par value. This TIPS is trading at a discount because its real yield now surpasses the coupon rate of 0.125%.

The price investors actually pay at Thursday’s auction will look a little different, however. This TIPS will carry an inflation index of 1.03672 on the settlement date of May 31. That means an investor will pay roughly $103.10 for $103.67 of value, after accrued inflation is added in. In other words, you’ll pay more, but get a matching amount of additional principal.

Side note 1: Note the significance of that 1.03672 inflation index. It means that non-seasonally adjusted inflation will have increased 3.67% in just four and a half months, ending on May 31. That’s amazing.

Side note 2: Ponder just how fast real yields have increased as the Fed began reversing its aggressive quantitative easing of the last two years. On November 18, 2021, a reopened 10-year TIPS auctioned with a real yield to maturity of -.1.145%, the lowest in history for this term. Thursday’s auction looks likely to be about 135 basis points higher … in just six months.

Definition: The “real yield” of a TIPS is its yield above or below official U.S. inflation, over the term of the TIPS. So a real yield of 0.20% means an investment in this TIPS will exceed U.S. inflation by 0.20% for 9 years, 8 months.

Of course, we can’t know what Thursday’s auction price and real yield will be. The Treasury market is experiencing strong volatility. But the trend is definitely higher for real yields, as shown in these Treasury estimates for a full-term 10-year TIPS:

  • March 1, 2022: -0.90%
  • April 1, 2022: -0.41%
  • April 18, 2022: -0.07%
  • May 2, 2022: 0.18%
  • May 13, 2022: 0.24%

Now let’s take a look at the big picture, with this chart of 10-year real yields over the last 12 years:

This chart shows two full Fed easing cycles: 2011 to 2014 and then 2019 to 2022. The middle section, where real yields are positive, shows what happens when the Fed sustains tightening. In the last tightening cycle beginning in 2014, the Fed gradually increased short-term interest rates and then later began reducing its balance sheet of Treasurys, but even then only made half-hearted reductions.

Here is that same chart with the Federal Reserve’s balance sheet of Treasurys overlaid on the 10-year real yield. Notice that when the Fed increases its balance sheet, it does so aggressively. When it reduces it, as in 2019, it does it very gradually (at least in the past):

Click on image for a larger version.

When the Fed eases — lowering short-term rates and adding to its Treasury holdings — real yields dip well below zero. When the Fed backs off, real yields normalize, above zero. That is where we are today. Except the huge difference in 2022 is that U.S. inflation is running at 8.3% and the Fed knows it has to act aggressively to raise rates and lower its balance sheet. We are only a small step along that process, in my opinion, but the bond market is already pricing in some of the future Fed actions.

Inflation breakeven rate

With a nominal 10-year Treasury trading Friday with a yield of 2.92%, CUSIP 91282CDX6 currently has an inflation breakeven rate of 2.74%, an entirely reasonable number with U.S. inflation running at 8.3%. But as I noted, the bond market has been pricing in future Fed actions, and the market believes inflation can be held in check. In normal times, I’d consider 2.74% a high breakeven rate, but these aren’t normal times.

Here is the trend in the 10-year inflation breakeven rate over the last 12 years, showing that by historical standards, these breakeven rates have tended to top off around 2.6%:

Some thoughts on the auction

If the real yield can hold above zero, CUSIP 91282CDX6 would mark a milestone for TIPS investors, with the first positive real yield after 12 consecutive 10-year auction offerings yielding negative to inflation. I’m calling this attractive. Better yields could be coming, but this one is worth a look.

TIPS vs I Bonds. With a real yield of 0.20%, is a 10-year TIPS more appealing than an I Bond with a real yield of 0.0%, based on the current fixed rate? I’d say no, but things are getting close. The I Bond has advantages because of its flexible maturity date, better deflation protection and built-in deferred federal taxes. The TIPS can be traded on the secondary market, which can be a positive or a negative. I’d still prefer I Bonds for my first $10,000 a year in inflation protection. But this 10-year TIPS looks like a good alternative, if the yield can sustain above zero.

Another advantage for TIPS is that investors can use retirement account money to buy a TIPS in an IRA brokerage account. That means there is no consequence in raising money for the purchase. Sell something, buy something, all in the same account. I Bonds can’t be held in an IRA account, so investors can face tax consequences in raising cash for an investment.

Reader alert: I will be traveling again

I’ll be a buyer of this TIPS, adding to my recent “nibble” purchases as real yields have been rising. This should be the most attractive auction in more than two years.

This auction closes for non-competitive bids at TreasuryDirect at noon EDT on Thursday. If you are buying through a brokerage account, you should make your purchase either Wednesday evening or early Thursday, because auction orders close early at brokerages.

I will attempt to post the auction result soon after it closes at 1 p.m. EDT Thursday. However, I will be out of the country (again), and I can’t be certain of my schedule Thursday. Where am I going? The photo at the right provides a hint.

Until then, here is a history of recent 9- to 10-year TIPS auctions, going back five years. It’s hard to remember, but as recently as November 2018, a 10-year TIPS auctioned with a real yield of 1.109%. Soon after, the stock market tanked and the Fed backed off. A year later, the global pandemic hit. Such interesting times:

* * *

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 | 18 Comments

Podcast: ‘Inflation Guy’ explains peak inflation

Posted on May 13, 2022 by Tipswatch

Are we there yet? Probably. Are our troubles over? No.

By David Enna, Tipswatch.com

If you’ve been reading coverage of Wednesday’s April inflation report, you might have noticed two strains of news spin: 1) “Inflation is coming down,” or 2) “Inflation is stubbornly high.”

Both takes are true, and sometimes politics may flavor how the media look at current U.S. inflation, which I might mention (totally apolitically) remains at a 40-year high.

I applaud the New York Times for this straightforward take: “Consumer Prices Are Still Climbing Rapidly” and the Wall Street Journal did well with: “Inflation Slipped in April, but Upward Pressures Remain.” And I like how the Washington Post covered all the bases with: “Pace of inflation eases slightly in April but still at 40-year high.”

Less impressive, from MSNBC: “Steve Rattner: U.S. inflation may have peaked” or this, from CNN: “US inflation slowed last month for the first time since August.” Fox Business spun in the opposite direction: “Inflation soars 8.3% in April, hovering near 40-year high.”

OK. In other words, the correct answer is that annual inflation did decline slightly in April, but the U.S. remains in a deep, deep inflationary mess.

Have we hit ‘peak inflation’?

For the answer, let’s turn to Michael Ashton, an inflation guru who explains his thoughts just about weekly in his “Cents and Sensibility” podcast. In this week’s episode, he analyzes the April inflation report, and explains that while inflation may have “peaked” in March, prices are likely to continue climbing, briskly higher, well into 2023.

His take on “peak inflation”:

Peak inflation means different things to different people. … I think some of our leaders are making a big mistake trumpeting peak inflation, which to an economist means that the rate of change is going to decline. … But the consumer, who is not an economist, hears the promise that, hey, we are past the worst inflation and they hear prices are going to go down now. … When we say peak inflation, we mean the rate of change is going to slow, but prices are going to keep going up.

Here is his podcast intro: Have we peaked? Well, arguably the Inflation Guy peaked in his 20s but we are talking about inflation here. While CPI has nominally peaked in terms of its year over year rate of change, that doesn’t mean prices are going to go ‘back to normal.’ Even more important: it doesn’t mean that we have reached peak inflation pressure. Listen while the Inflation Guy explains.“

Take a listen:

Direct link to podcast

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.

* * *

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 | 6 Comments

U.S. inflation rose 0.3% in April, again exceeding expectations

Posted on May 11, 2022 by Tipswatch

While annual inflation dipped slightly, inflation continues to run hot — too hot for complacency by the Federal Reserve.

By David Enna, Tipswatch.com

When is a surprise not a surprise? When it comes to economists trying to predict U.S. inflation.

All-items U.S. inflation rose 0.3% in April, exceeding economist predictions of 0.2% for the month and continuing a string of monthly upside surprises. The year-over-year number was 8.3%, also exceeding expectations of 8.1%. Core inflation looked even worse, coming in at 0.6% for the month (beating expectations of 0.4%) and 6.2% for the year (versus 6.0%).

The stock market’s instant reaction was negative. Just minutes before the Bureau of Labor Statistics released the report at 8:30 a.m., S&P 500 stock market futures were trading at 3996. Minutes after the report, futures were down to 3969.

In April, U.S. inflation rose 0.3% even though the price of gasoline — a major factor in the monthly all-items report — actually declined 6.1%, but remained 43.6% higher year over year. Already, this trend has reversed, with gas prices rising to record highs in May.

The BLS noted that increases in the indexes for shelter, food, airline fares, and new vehicles were the largest contributors to the seasonally adjusted all-items increase. Some highlights:

  • The food at home index rose 1.0% in April, the fourth month in a row with price increases higher than 1%. Year over year, food at home prices were up a painful 10.8%.
  • Food prices have increased 17 months in a row. The BLS noted that the index for dairy and related products rose 2.5%, its largest monthly increase since July 2007. The index for eggs increased 10.3% in April.
  • Shelter costs increased 0.5% for the month and are now up 5.1% year over year. Shelter costs are a lagging indicator and should be a factor in higher inflation in coming months.
  • The cost of used cars and trucks fell 0.4% in April, but are still 22.7% higher year over year. The index for new vehicles was up 1.1% for the month.
  • Apparel prices also fell 0.8% in the month.
  • The index for airline fares increased a mammoth 18.6% in April, the largest one-month increase since the inception of the CPI-U series in 1963.
  • Costs of medical care increased 0.5% in April and are up 3.5% year over year.

Here is the trend in all-items and core inflation over the last year, showing that annual inflation did peak in March, but remained at a very high level in April:

Source: Bureau of Labor Statistics

A side note: The separate inflation index — CPI-W — used to determine Social Security’s annual cost of living increase has increased 8.9% over the last 12 months, a bit higher than overall U.S. inflation. But the Social Security increase for 2023 will be determined by the average of inflation from July to September. It’s too early to draw any conclusions.

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 TIPS and set future interest rates for I Bonds. For April, the BLS set the inflation index at 289.109, an increase of 0.56% over the March number.

Keep in mind that since non-seasonally adjusted inflation was running higher than the seasonally adjusted number in April, this will eventually reverse in coming months. The two numbers merge after 12 months.

For TIPS. The April inflation number means that principal balances for all TIPS will rise 0.56% in June, after rising 0.91% in April and 1.34% in May. Here are the new June Inflation Indexes for all TIPS.

For I Bonds. The April inflation index is the first of a six-months string — from April to September — that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on November 1. So far, that 0.56% number would translate to a variable rate of 1.12%, but it’s way too early to draw any conclusions from just one month. Inflation can be highly volatile in summer months.

Here are the data I’m tracking:

What this means for future interest rates

While annual inflation slipped slightly lower in April, the upside surprises for both all-items and core inflation indicate that the Federal Reserve has to stay the course with balance-sheet reductions and routine increases of 50 basis points in short-term interest rates.

I think the bond market has already priced in this trend, with the 5-year nominal Treasury rising above 3% earlier this week. The real yield of a 5-year TIPS is inching ever closer to zero and should quickly rise to positive, if the Fed stays the course and attempts to hold down inflation expectations.

I don’t expect annual U.S. inflation to continue above 8% for long. It should begin gradually slipping lower in coming months, possibly ending the year in the 4% to 5% range. This is what the market expects, but a lot will depend on if the U.S. economy can remain reasonably strong at a time of soaring energy prices and rising interest rates.

Next week’s reopening auction of a 10-year TIPS should be interesting. That TIPS is currently trading on the secondary market with a real yield of 0.32% and a price discounted to par. We haven’t seen that in a long time. I will be writing a preview article on that auction this weekend.

* * *

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 | 6 Comments

Ready to convert paper I Bonds into electronic form? Here’s a step-by-step guide.

Posted on May 8, 2022 by Tipswatch

Hint: It’s a bit complicated. What else would you expect?

Editor’s note: In October 2021, Wisconsin-based financial adviser Jeremy Keil invited me onto his podcast to talk about I Bonds. He was ahead of the curve on I Bonds, educating himself on a topic that would be of great benefit to his clients. Later on, he mentioned to me that he was going to get paper I Bonds in lieu of a federal tax refund, and then convert them to electronic I Bonds at TreasuryDirect. I asked him if he’d write a step-by-step description of the entire process, and here it is …

By Jeremy Keil, CFP®, CFA

Jeremy Keil

With purchases of US Series I Savings Bonds (I Bonds) exploding over the past year and a cap of $10,000 per person in electronic savings bonds, many people are trying to go past that cap by using their tax refund to buy up to $5,000 more.

They may be surprised to see these $5,000 savings bonds come in paper form and are curious how to convert them over to electronic form.

I went through the process of getting paper savings bonds from my tax return and converted them into my online Treasury Direct account so I could live to tell the tale and give you a step-by-step guide on how to do it.

How to get US Series I Savings Bonds from your tax return

If you are intentionally trying to get I Bonds from your tax refund you’ll likely want to overpay, on purpose, estimated taxes into the IRS, probably closer to the end of the year.

Make sure you are aware of:

Alert your tax preparer to your desire to receive part of your refund in paper savings bonds. Chances are you have already maxed out the Treasury’s $10,000 per person/entity per calendar year limit for I Bonds. With the added steps to get paper savings bonds, you likely want the $5,000 per return max if you’re going through this exercise.

After you file your return wait a few weeks (or months!) and you’ll get a series of envelopes in the mail from “Treasury Retail Securities.”

I was quite surprised to get a stack of multiple envelopes.

When I opened the first one it was for $50, and I thought “if they sent me 100 – $50 US Savings Bonds that’s crazy!” but it turned out they sent me 12 total bonds. 4 – $1,000; 1 – $500; 1 – $200; 6 – $50.

Then came the next step:

How to convert paper savings bonds into electronic form

Treasury Direct has a page that gives you some instructions, but below are the steps (with pictures) I took to convert my paper saving bonds into electronic form.

I’ll emphasize it again, but do NOT sign the back of your savings bonds at any time during this process.

I’m assuming you already have a Treasury Direct account. If not go here for instructions on how to open the account.

  1. Log in to TreasuryDirect.

2. Click on Manage Direct, one of the middle blue menu buttons at the top of the page.

3. Click on Establish a Conversion Linked Account

4. Next, click Create Account

5. You will then be in your “Conversion Account” – Click on Manage Direct again, in the blue box at the top of the page.

6. Under Manage My Conversions, click on “Convert my bonds.”

7. Select the Registration you are converting for (likely your own) and continue

8. Then start adding in paper savings bonds to your cart

9. Once you have added all your paper bonds, click view cart, and once you are ready, click Create a Manifest

10. You will now have a paper manifest you can use to print and mail in with your paper savings bonds. Do NOT sign the back of your savings bonds!

11. The manifest will give you a P.O. box and a physical mailing address. You will sign your manifest. Do NOT sign the back of your savings bonds!

I suggest using some sort of tracking system through USPS, UPS, or FedEx so that you can know when your savings bonds arrive, which means you’d likely mail it to the physical address, not the P.O. box.

I also suggest keeping a copy of your manifest, and making a copy of the savings bonds you send in.

12. Double check through the mail tracking system you used that the bonds arrived, and then wait a few weeks and you’ll see your paper bonds are now listed in your conversion account.

What comes next?

It’s an odd system, but you’ll essentially have two accounts through Treasury Direct that are accessed through your main account login.

The first is your regular login that will list out your current securities total, and your current holdings.

The second is listed towards the bottom of the page, and you’ll have to click on My Converted Bonds to get into and transact on that part of your account.

Now that you know how to link your paper savings bonds into your online TreasuryDirect account, please spread the word – especially to people like your parents who probably have old paper savings bonds.

* * *

Jeremy Keil, CFP®, CFA is a retirement focused financial planner with Keil Financial Partners. If you have retirement, investment or tax planning questions Jeremy’s team can get you started in the right direction.

Jeremy also hosts the Retirement Revealed blog and podcast where you will learn more about your money, feel better about your money and make better money decisions.

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 I Bond, Savings Bond | 40 Comments

Podcast: ‘Inflation Guy’ questions the Fed’s resolve to fight soaring prices

Posted on May 5, 2022 by Tipswatch

“The recession isn’t going to happen tomorrow, but it will happen next year.”

Tipswatch.com

As we all expected, the Federal Reserve raised its key short-term interest rate by 50 basis points on Wednesday, while also announcing plans to begin paring back its balance sheet in June. And then .. the stock market roared about 3% higher on the news. Federal Reserve Chairman Jerome Powell triggered the surge with these words at his afternoon press conference:

So a 75-basis-point increase is not something the committee is actively considering. … there’s a broad sense on the committee that additional 50-basis increases should be on—50-basis-point increases should be on the table for the next couple of meetings.

It was a brilliant move by the Fed, in my opinion. Brilliant in the sense of setting up expectations in recent weeks — a 75 basis point increases was “possible” — and then knocking down that idea, making multiple increases of 50 basis points seem appealing. The stock market, which has been slumping for weeks, celebrated with a one-day party.

That’s how I saw it. Now let’s hear from Michael Ashton, an inflation guru who explains his thoughts just about weekly in his “Cents and Sensibility” podcast. In this episode, titled “Reflections on this Century’s First 50bp Rate Hike,” Ashton points out that the Fed did what was expected, and there is no danger in doing what is expected.

But he also warns about complacency on the U.S. economy, which could be heading toward a difficult stretch, even with inflation continuing in a 4% to 5% range next year:

I can’t think of any examples in history where you had a large increase in energy prices, not to mention food prices, and large increases in interest rates … and didn’t have a recession. That would be very odd. … The recession isn’t going to happen tomorrow, but it will happen next year.

And this forecast raises the “big” question: Will the Fed have the nerve to continue fighting inflation even when stocks fall into a bear market and the economy is suffering? Ashton contends that the “Fed put” — its resolve to protect the stock market — remains alive, even it it is in hiding.

Here is his podcast intro:

Today the Federal Reserve raised the overnight Fed Funds rate 50bps – the largest such increase since May 2000 (and the Inflation Guy is sticking by the title of this episode since technically the 20th century didn’t end until 12/31/2000!), and Chairman Powell strode confidently to the microphone in the post-meeting presser. How does this action, and what Powell said, impact the inflation outlook and why did the markets behave the way they did? (The answers are: not much, and for unhealthy reasons, but listen to the podcast anyway.)

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.

* * *

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 | 13 Comments