U.S. inflation surged 0.6% in January, again higher than expectations

Posted on February 10, 2022 by Tipswatch

Inflation is running at a 40-year high. What does it mean for I Bonds, TIPS and future interest rates?

By David Enna, Tipswatch.com

Once again, U.S. inflation is running higher than expectations, a trend that will probably continue through the early months of 2022.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6% in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 7.5%, the largest 12-month increase in 40 years, since the period ending February 1982.

Both the monthly and year-over-year increases exceeded economist expectations of 0.5% for the month and 7.3% for the year. Core inflation, which removes food and energy, also exceeded expectations, running at 0.6% in January (versus expectations of 0.5%) and 6.0% for the year (versus 5.9%). The year-over-year number for core was the largest 12-month change since the period ending August 1982.

And this jump higher in inflation came despite the fact that gasoline prices actually fell in January, a trend that is likely to reverse in coming months. The BLS noted that a wide range of price increases contributed to January’s surge in inflation. Some highlights:

  • Food-at-home prices increased a troubling 1% in the month, and are now up 7.4% over the last year.
  • Gasoline prices fell 0.8% for the month, but are up 40% over the last year. This decline is highly likely to reverse in future months, as the price of WTI Crude has increased about 35% in the last two months.
  • Shelter costs rose 0.3% for the month, and are up 4.4% over the last year. This is another category where higher prices can be expected into the future.
  • Costs of electricity surged 4.2% in the month and are up 10.7% year-over-year.
  • Apparel prices, once a sleepy sector in the CPI report, were up 1.1% in January.
  • Prices for used cars and trucks continued surging higher, up 1.5% in the month and 40.5% for the year.
  • New car prices held stable, but are up 12.2% for the year.
  • The medical care index rose 0.7% for the month.

To wrap things up, the BLS said this: “The increase is broad-based, with virtually all component indexes showing increases over the past 12 months.”

Here is the one-year trend for all-items and core inflation, showing the remarkable climb higher from very low levels of inflation in January 2021:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates for I Bonds. For January, the BLS set the inflation index at 281.148, an increase of 0.84% over the December number.

For TIPS. The January inflation report means that principal balances for all TIPS will increase 0.84% in March, following an increase of 0.31% in February. For the year ending in March, TIPS principal balances will have increased 7.5%. Here are the March inflation indexes for all TIPS.

For I Bonds. The January inflation report is the fourth in a six-month series that will determine the I Bond’s new inflation-adjusted variable rate, to be reset on May 1 based on non-seasonally adjusted inflation from September 2021 to March 2022. So far, with two months remaining, inflation has increased 2.49%, which would translate to an I Bond variable rate of 4.98%. Two months remain, and that rate is likely to climb higher. Here are the data so far:

What this means for future interest rates

Clearly, interest rates are heading higher. This inflation report continues a string of higher-than-consensus numbers, even though the consensus forecasts have been rising. Already this morning the 10-year Treasury note is trading with a yield of 1.98%, very close to breaking through the 2% barrier, a level we haven’t seen since July 2019. And stock market futures are falling, indicating the markets are again adjusting to a future with higher interest rates.

From this morning’s Wall Street Journal report:

High inflation is the dark side of the unusually strong economy, posing a challenge to the Federal Reserve as it tries to quell rising prices without damping growth.

“This is not encouraging news for the Fed in its battle to get inflation heading back towards the 2% target,” said James Knightley, chief international economist at ING. “Rate hikes will do nothing to resolve supply chain strains and worker shortages, but they can contribute to taking some of the steam out of the economy and allow demand and supply to start moving towards a better balance, at the expense of weaker growth.”

I’m sure the Federal Reserve has a very good idea where prices are heading, and the current trend of 40-year inflationary highs must be addressed. An easy prediction: Expect the Fed to begin raising short-term interest rates in March, and continue raising them through 2022.

What will happen to longer-term rates? That will depend on the economy and the stock market’s reaction to Fed actions. In the next few months, longer-term rates should climb higher, but possibly stabilize if the economy begins sinking or the stock market plummets.

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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 | 14 Comments

30-year real yield cracks through a milestone, rising above zero

Posted on February 6, 2022 by Tipswatch

Real yields are rising. Noticed that your TIPS fund or ETF has taken a hit?

By David Enna, Tipswatch.com

Maybe it’s not really an Earth-shattering event, but something significant happened Friday: The real yield on a 30-year Treasury Inflation-Protected Security rose above zero for the first time since May 21, 2021.

At Friday’s market close, the U.S. Treasury estimated the real yield of a full-term 30-year TIPS at 0.06%, up 39 basis points since the beginning of the year. This happened the day after the Treasury revamped the presentation of its Yields Curve site, which sent my head spinning. But Bloomberg’s Current Yields site showed that a 29-year, 6-month TIPS closed Friday with a real yield to maturity of 0.04%, so there you go … confirmation that the entire TIPS yield curve is no longer negative to inflation.

Bloomberg took note of this in a story posted Friday morning, noting the surge in yields after an important jobs report surprised to the upside earlier Friday:

It’s already been a tough start to a year for Treasury investors. U.S. government bonds lost about 2.1% this year through Thursday, according to the Bloomberg U.S. Treasury Total Return Index. The loss is already approaching the full-year decline of 2.3% last year, which was the first annual decline since 2013.

“We have to price in more risk that the Fed goes really aggressively, so we’re seeing most of the pressure on the front end of the curve,” said Michael Cloherty, head of U.S. rates strategy at UBS Securities. “As central banks get tighter that should push up real rates.”

I have been speculating that both real and nominal yields could quickly surge higher as the Federal Reserve approaches actions to raise short-term interest rates and eventually to pare back its massive balance sheet of Treasurys and mortgage-backed securities. It turns out that 2022 is starting to look a lot like 2013, when real and nominal yields burst higher in anticipation of Fed actions:

Note in this chart that annual inflation was running at a muted 1.5% through 2013, which allowed the Federal Reserve to delay tightening. This year, with inflation running at 7.0%, the Fed can’t put off decisive actions, and the market is adjusting quickly to that reality.

Here is the trend in the 30-year real yield over the last three years:

These three years have been a remarkable era for Fed policy, beginning in 2019 with the tail end of a period of tightening, through a period of moderate interest rate cuts in 2019, to all-out massive stimulus in 2020 and 2021 to calm the market shock that resulted from the pandemic surge in March 2020.

Now we are entering the “next era,” with inflation surging and the Federal Reserve almost certainly ready to raise short-term interest rates multiple times in 2022. Here is how real yields have increased over the last five months:

It’s no surprise that short-term real yields are rising faster than the longer-term yields. Fed actions to raise short-term nominal interest rates will have the greatest effect on the 5-year TIPS because it is the shortest maturity. Eventually, as short-term rates rise, longer-term yields may ease off, flattening or even inverting the yield curve. This happened in late 2018, setting off stock market panic and forcing the Fed to back off on tightening in 2019.

What’s happening to TIPS funds?

When real yields rise, the value of a TIPS falls. So, obviously, TIPS mutual funds and ETFs have hit a difficult stretch in recent months, but returns have been aided by high inflation accruals over the last year. This is why it is important to analyze TIPS funds based on total return, not net asset value.

The chart compares total returns for Vanguard’s Short-Term TIPS ETF (VTIP), the iShares TIPS ETF (TIP) and Vanguard’s Total Bond Market ETF (BND). Even though shorter-term real yields have been rising faster than longer-term yields, VTIP has outperformed the overall TIPS market and the overall bond market. TIPS funds have the advantage of inflation accruals, and as long as inflation continues running hot, these funds can balance off some of their net-asset-value losses caused by rising interest rates.

But I would still expect TIPS mutual funds and ETFs to have a difficult year in 2022, as interest rates rise. VTIP, with its shorter duration, should perform the best in this scenario, but it could still end up with a negative return for the year. Taking a longer view, higher real and nominal interest rates will be a positive for investors looking to add new money in inflation-protected investments.

Is the I Bond’s fixed rate affected at all?

The U.S. Treasury will reset the fixed rate of the U.S. Series I Savings Bond on May 2. The rate is currently 0.0%, and in my opinion looks very likely to remain at 0.0% through the May reset. The 10-year real yield is currently -0.48% and would need to rise at least 75 basis points in the next three months to make a higher fixed rate at all likely. I don’t see that happening, but you never know.

If real yields surge higher through 2022, it’s possible the fixed rate could rise in November. Still, the current annualized variable rate of 7.12% on I Bonds is too attractive to pass up. I think an investment before May 1 is the wisest course. The next variable rate, also to be reset on May 2, should be at least 4.5%, maybe much higher. Can’t pass up 12 months of very strong returns for the outside chance for a higher fixed rate in the future.

Look back at the Fed’s last tightening cycle

Back in July I did a series of articles looking at how real and nominal yields reacted when the Fed first began discussing tightening in 2013, stopped bond buying in 2014, and eventually began raising interest rates in late 2015. Through most of this period, surprisingly, the stock market did very well. Bond markets took some hits, but eventually recovered.

2013: A year of surging real and nominal yields
2014: The deck was stacked against TIPS funds
2015: The Fed actually did something!
2016: Inflation rises; TIPS out-perform the overall bond market
2017: ‘The calm before the storm’
2018: Did the Federal Reserve go too far?
2019: The Fed cries ‘uncle’; bond investors celebrate
2020: Chaotic year of pandemic fears, stunning stimulus
2021 and beyond: What’s ahead for U.S. financial markets?

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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 | 13 Comments

New 10-year TIPS auctions with a real yield of -0.540%

Posted on January 20, 2022 by Tipswatch

The auctioned real yield came in higher than current market pricing, indicating fairly weak demand for this offering.

By David Enna, Tipswatch.com

The Treasury’s offering of $16 billion in a new 10-year Treasury Inflation-Protected Security — CUSIP 91282CDX6 — generated a real yield to maturity of -0.540%, above current market yields for TIPS of this term. The issue got a coupon rate of 0.125%, the lowest the Treasury will go for any TIPS.

At the market close yesterday, the U.S. Treasury was estimating the 10-year real yield at -0.57%, a bit lower than today’s result. In addition, a 9-year, 6-month TIPS was trading this morning on the secondary market with a real yield of -0.65%, well below the auction result.

So it looks like this auction was met with lukewarm demand and the Treasury was forced to give this TIPS a slightly higher real yield than predicted. The question: Are investors sitting on the sidelines, waiting to see how interest rates will trend in coming months?

Today’s investors paid an adjusted price of about $107.08 for about $100.25 of value, after accrued inflation is added in. This TIPS will have an inflation index of 1.00253 on the settlement date of Jan. 31. Investors had to pay a premium price because the real yield of -0.540% is well below the coupon rate of 0.125%.

So, it looks like investors got a bit of a bargain at today’s auction. The real yield of -0.540% was the highest recorded for any 9- to 10-year TIPS auction since May 2020.

Real yields have been climbing in recent weeks, following signals that the Federal Reserve intends to stop bond-buying stimulus in March, and then begin raising short-term interest rates. Here is the trend in 10-year real yields over the last year, showing how yields have climbed since deep lows in August and November 2021:

Inflation breakeven rate

With a 10-year Treasury note trading with a nominal yield of 1.83% at the auction’s close, this new TIPS gets an inflation breakeven rate of 2.37%, which seems attractive. The rate means this TIPS will out-perform a nominal 10-year Treasury if inflation averages more than 2.37% over the next 10 years.

Inflation expectations have been falling since late 2021, triggered by investor belief that the Federal Reserve will take needed actions to tamp down soaring inflation. Here is the trend in the 10-year inflation breakeven rate over the last year.

Reaction to the auction

The TIP ETF — which holds the full range of maturities — had been trading higher all morning, indicating lower yields. But after the auction’s close at 1 p.m. EST, the ETF slipped lower. This is an indication of lukewarm support for the auction. In addition, the bid-to-cover ratio was 2.30, the lowest for any TIPS auction of this term in more than a year.

The Treasury might be disappointed — it had to pay a slightly higher yield than expected — but investors at today’s auction should be pleased. The real yield of -0.54% was 60 basis points higher than the most recent auction of this term. That auction, in November 2021, resulted in a record-low real yield of -1.145%.

Personal note: I considered making a small investment in this TIPS in my Vanguard brokerage account , but I didn’t realize that Vanguard closes off auction orders at 10 a.m. on the morning of the auction. I swear it was 9:55 a.m. when I looked to make an order, but I got cut off. Lesson learned. I don’t know if this is true at other brokerages.

Anyway, this TIPS will get reopening auctions in March and May. Maybe we will see even better yields by then. Here’s a history of recent auctions, showing the string of 11 auctions of this term with negative real yields.

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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 | 7 Comments

A 10-year TIPS matured Jan. 15. How did it do as an investment?

Posted on January 19, 2022 by Tipswatch

CUSIP 912828SA9 was the first-ever 10-year TIPS to auction with a negative real yield. Still, it ended up out-performing its nominal counterpart.

By David Enna, Tipswatch.com

On January 15, 2022, a 10-year TIPS — CUSIP 912828SA9 — matured. It was first auctioned on Jan. 19, 2012, with a real yield to maturity of -0.046% and a coupon rate of 0.125%. That auction made history as the first-ever 10-year TIPS to receive a negative real yield. The numbers are uninspiring, but look fairly attractive today after a decade of much lower negative real yields.

Here’s the question: How did CUSIP 912828SA9 do as an investment versus a nominal 10-year Treasury? It turns out … well … it did OK.

I’ve been writing about Treasury Inflation-Protected Securities since 2011, and I’ve been investing in these products since 1999. I track the performance of every maturing 10-year and 5-year TIPS, as they mature in January, April and July. For more on this, see my ‘Tips vs. Nominals‘ page.

Here’s what I wrote back on Jan. 9, 2012, in my preview article about CUSIP 912828SA9:

The 10-year TIPS auction of Jan. 19 will be interesting to watch. Will it make history with a first-ever negative yield for a 10-year TIPS? And is that still attractive to buyers? … We are certainly entering uncharted waters for Treasury yields. Uncharted waters ought to make you uneasy. A negative real return over the next 10 years ought to make you uneasy. But there are no super-safe alternatives, and TIPS protect you against an unexpected rise in inflation.

On the day CUSIP 912828SA9 auctioned, a nominal 10-year Treasury was yielding 2.01%, creating an inflation breakeven rate of 2.06%. As it turned out, thanks to some lofty inflation numbers in recent months, inflation over those 10 years averaged 2.1%, and the TIPS investment ended up being the winner, by a small margin.

In general, 10-year TIPS have performed better when the inflation breakeven rate dips below 2.0%. Right now the 10-year breakeven is about 2.46%. Does that make a 10-year TIPS unattractive? I’d say no.

TIPS have been under-performing nominal Treasurys for most of the last decade because inflation for much of that time ran lower than expectations. We seem to have turned the corner on that, with official U.S. inflation now running at 7.0%, much higher than expectations. Will that trend continue? It seems likely, for awhile at least.

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

Annualized inflation data from Eyebonds.info, based on CPI-U index 2 months before TIPS issue and maturity. Chart shows only new issues.

Notes and qualifications

This chart is an estimate of performance, because it uses a full month of inflation in the ending month, 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 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

10-year TIPS auction: Real yields are rising

Posted on January 16, 2022 by Tipswatch

Thursday’s auction of a new 10-year TIPS will get a real yield nearly 50 basis points higher than a similar auction in November. But is that enough?

By David Enna, Tipswatch.com

The U.S. Treasury will offer a new 10-year Treasury Inflation-Protected Security at auction on Thursday, and the real yield to maturity will almost certainly be a negative number. A negative yield? Does that mean investors will earn less than zero on this investment? Of course not.

I bring this up because the New York Times ran an article this week implying that investors in TIPS are guaranteed to lose money on their investment. Utterly ridiculous, and the New York Times should know better. Here is what the Times reported:

“People assume ‘just because inflation goes up, you’ll do well’ with TIPS, said Lynn K. Opp, a financial adviser with Raymond James in Walnut Creek, Calif. But other factors, like rising interest rates, can sap TIPS’s returns, she said.

“Plus, TIPS are expensive when compared with standard Treasuries in that they pay less interest, Ms. Opp said. In the first week of January, a five-year TIPS was yielding minus 1.7 percent, while a five-year Treasury was yielding 1.4 percent. In effect, TIPS investors were paying the Treasury to hold their money.

No. No. No. I know that TIPS can be a complicated investment to understand, but any financial advisor should know that a real return of -1.7% means only that the investment will lag official U.S. inflation by 1.7% a year over its term. Inflation currently is running at 7.0%, which translates to a nominal return of 5.3% for that TIPS, much better than the nominal Treasury at 1.4%. If inflation falls to 4%, that TIPS would yield 2.3%, still much better than 1.4%.

A negative real return does not mean a negative nominal return. And a positive nominal return — as you can get on that 5-year Treasury paying 1.4% — does not mean a positive real return. Simple as that.

One more point on that Times article: A 5-year TIPS never had an estimated real yield of -1.70% in January. The lowest it got was -1.56% on Jan. 4, and that yield had increased to -1.24% on the date the article was published. This is sloppy reporting. TIPS have pluses and minuses, but paying the Treasury to hold your money is not an issue.

Rant over. On to the auction.

The Treasury on Thursday will offer $16 billion in a new 10-year TIPS — CUSIP 91282CDX6. The real yield to maturity and coupon rate will be set by the auction, but we can be sure the real yield will be negative and the coupon rate will be set to 0.125%, the lowest the Treasury will go on a TIPS.

The best source for estimating the real yield of a new TIPS is the U.S. Treasury’s Real Yields Curve page, which updates an estimate each day at the close of trading. As of Friday’s market close the Treasury was estimating that a full-term 10-year TIPS would yield -0.66%, which is up 31 basis points from the start of the year.

Real yields (and nominal yields, too) have been rising after the Federal Reserve signaled it is ready to end its aggressive bond buying by March, and also likely to begin raising short-term interest rates in that month. We could see as many as four increases in short-term rates in 2022, and eventually, the Fed should begin reducing its $8.8 trillion stockpile of Treasurys and mortgage-backed securities.

So we could see real yields continue to climb before Thursday’s auction, but both the bond and stock markets seem to be heading into a volatile phase.

If the auction does result in a real yield of -0.66%, that should result (roughly) in an unadjusted price for investors of about $107.85 for $100 of par value. This TIPS will carry an inflation index of 1.00253 on the settlement date of Jan. 31, which means the adjusted price should be around $108.12 for $100.25 of value, after accrued inflation is added in.

Reminder: that’s a rough estimate, and things change. But investors should be prepared for that higher cost, which is necessary because the real yield to maturity will be well below the coupon rate of 0.125%.

Is a real yield of -0.66% attractive? Hey, at least it is well above the record low of -1.145% set at a TIPS reopening auction in November. That TIPS carried a premium cost of 15%. So this TIPS should get a real yield about 48 basis points higher than investors accepted just two months ago.

The key question is: Will this trend of rising real yields continue through 2022, making later auctions of this term more attractive? I’d say that is likely, but nothing is certain. Here is the trend in 10-year real yields over the last three years:

This chart is interesting because it shows that 10-year real yields were closing in on 1.0% in early 2019, following a period of Federal Reserve tightening. That could be the “new normal” for 2023 and beyond if the Fed stays on course to raise rates and reduce its balance sheet. However … the Fed does change course quickly. Back in 2019, it backed off and began reducing interest rates after the stock market had a volatile month in December 2018. More on that.

Inflation breakeven rate

With a nominal 10-year Treasury note yielding 1.78%, a 10-year TIPS would currently have an inflation breakeven rate of 2.44%, which seems reasonable (and actually attractive). I can visualize inflation running at a rate of 3% or higher over the next decade, but that would be a dramatic break from the last decade of lower-than-expected inflation.

Simply put, a lower inflation breakeven rate indicates that a TIPS is getting more attractive versus a nominal Treasury of the same term. Would I want to invest in a 10-year Treasury yielding 1.78%? No. Would I want to invest in a TIPS that would lag official inflation by 0.66% over 10 years? Maybe, because the TIPS offers protection against unexpectedly high inflation. We could be entering an era of unexpectedly high inflation.

Here is the trend in the 10-year inflation breakeven rate over the last three years, showing the massive surge higher after the pandemic mania of March 2020, and the less dramatic dip lower in recent weeks, in reaction to the Federal Reserve’s potential actions to tamp down inflation:

Conclusion

I can see the appeal of this auction, with real yields rising nearly 50 basis points since the last auction of this term in November. But will we see higher real yields later this year? The Treasury schedules opening and reopening auctions of this term every other month, so there will be a lot of opportunities. I’ll probably pass.

Also, remember that the first $10,000 you invest in inflation production in 2022 should go to U.S. Series I Savings Bonds, which in effect have a real yield of 0.0%, 66 basis points higher than a 10-year TIPS. In reality, that means an I Bond is about 7.5% more valuable than a 10-year TIPS, plus it offers better deflation protection, a flexible term and tax-deferred interest.

Thursday’s auction result closes at 1 p.m. EST for non-competitive bids, like the ones made at TreasuryDirect or a brokerage. I’ll be reporting on the auction results soon after the close. In the meantime, here is the recent history of TIPS auctions of this term. Note that Thursday’s result will be the 11th consecutive auction with a negative real return:

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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 | 8 Comments