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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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.
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.
“The Fed is in a real pickle. … Being on the tightening side of monetary policy is no fun.”
Here is this week’s “Cents and Sensibility” podcast from inflation guru Michael Ashton. I am a big 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.
His podcast intro: “Inflation continues to show broader and deeper, and now is entering the general business and consumer mindset. In this episode, Inflation Guy talks about the idea that year-over-year inflation may peak soon, but probably won’t go back to the old 2% level. In the long term? Well, that depends on whether the Fed can channel Paul Volcker, and worry less about breaking eggs and more about whether we can afford eggs.”
Have a listen:
You can subscribe to this podcast in all the traditional ways, or find it here.
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.
December all-items inflation increased 0.5%, slightly higher than expectations.
By David Enna, Tipswatch.com
This seemed impossible just 12 months ago, when U.S. inflation ran at 1.4% for 2020. But December’s price increases continued an ominous trend in 2021, with annual inflation ending the year at 7.0%, the highest rate in 40 years.
For December, the Consumer Price Index for All Urban Consumers increased 0.5% on a seasonally adjusted basis, the Bureau of Labor Statistics reported. That was slightly higher than the consensus estimate of 0.4%. Year-over-year inflation ran at 7.0%, the BLS said, slightly below the consensus.
This is the final inflation report of 2021, and the 7.0% increase for the year is the largest since 1981, when inflation ran at 8.9%. In the 40 years following 1981, end-of-the-year annual inflation has never exceeded 6.1%, until 2021.
Core inflation, which removes food and energy, rose 0.6% for December, following a 0.5% increase in November. Year-over-year core inflation was 5.5%, the highest annual increase since 1991. Inflation for both the month and the year were higher than expected.
Gasoline prices, usually a trigger for higher U.S. inflation, actually fell 0.5% in December, but are up 48.9% for the year. (Before seasonal adjustment, gasoline prices fell 2.2% in December.) When inflation rises without a boost from energy prices, you know it is surging across the economy. For example:
Food prices were up 0.5% for the month, and increased 6.3% for the year.
The index for fruits and vegetables increased rose 0.9% over the month.
On the other hand, the index for meats, poultry, fish, and eggs declined in December, falling 0.4% after rising at least 0.7% in each of the last seven months.
Shelter costs increased 0.4% for the month and 4.1% for the year.
Costs of used cars and trucks continued surging, rising 3.5% for the month and 37.3% for the year.
New vehicle prices rose 1.0% for the month and were up 11.8% for the year.
The apparel index rose 1.7% for the month, following a 1.3% increase in November.
To sum things up for 2021, The BLS stated:
“Major contributors to this increase include shelter (+4.1 percent) and used cars and trucks (+37.3 percent). However, the increase is broad-based, with virtually all component indexes showing increases over the past 12 months.”
Here is the U.S. inflation trend over the last year, showing the strong move higher for both all-items and core inflation since September:
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 December, the BLS set the inflation index at 278.802, an increase of 0.31% over the November number.
Note that the non-seasonally adjusted increase of 0.31% lagged behind the adjusted inflation number of 0.5% for the month, most likely caused by the dip in gasoline prices, a decline of 2.1% before adjustment, but 0.5% after. These types of variations will balance out over a year.
For TIPS. The December inflation report means that principal balances for all TIPS will increase 0.31% in February, following a 0.49% increase in January. In February, balances for the year will be up 7.0%. Here are the new February Inflation Index Ratios for all TIPS.
For I Bonds. The December report is the third in a six-month series that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset May 2 based on inflation from September 2021 to March 2022. After three months, inflation has been running at 1.64%, which translates to an I Bond variable rate of 3.28%. Keep in mind that three months remain, and also that lagging non-seasonally adjusted inflation in November and December should reverse in coming months.
Here are the relevant numbers:
What this means for future interest rates
In congressional testimony this week, Federal Reserve Board Chairman Jerome Powell signaled strongly that the Fed is prepared to raise short-term interest rates in 2022, beginning as soon as March. It looks like three rate increases in 2022 are a sure thing, and if inflation continues at a high rate into the summer, four increases are likely. That would bring the Federal Funds Rate up to a range of 1.00% to 1.25% by the end of the year.
Today’s inflation report reinforces the need for Fed action. There were few surprises in this report, but it is clear that the inflationary surge is continuing. That could be a hard trend to break. The stock market is opening higher this morning, indicating that this report was “digestible,” at least.
Inflation is likely to continue at a very high rate at least through March, which more or less ensures that the Fed will need to make that initial rate hike. The markets seem prepared for it. It needs to happen.
Inflation guru Michael Ashton posted this today on his E-piphany site, which includes a ton of analysis of today’s report:
“The Fed is talking tough, but talk is cheap. They’re still easing at this hour! Eventually they’ll stop digging the hole. When will they start filling it in – not by raising rates which has small effect if any on inflation, but by selling bonds? Don’t hold your breath. …
“This was, sadly, not a very surprising report. Inflationary pressures remain broad and deep, and the Fed today is still purchasing bonds and adding more reserves to the system. … So now, they’re behind the curve and really need to catch up and get ahead of this process.”
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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.
In one week, real yields have increased as much as 30 basis points. Will this trend continue? Yes, if the Fed continues on its current course.
By David Enna, Tipswatch.com
In the last week, the U.S. bond market seems to have finally faced up to reality: There is no longer any reason for interest rates — both real and nominal — to continue at ridiculously low levels. This could either be the beginning of a months-long trend higher, or just another bond market head fake.
Several news events and trends have combined to bring us to this point, including continued very high U.S. inflation, research showing that the Omicron Covid variant is less lethal, and several positive jobs reports. But the key event seems to have been the release of the Dec. 14-15 minutes of the Federal Reserve’s Open Committee Meeting. This is how the Wall Street Journal summarized those minutes:
“Federal Reserve officials at their meeting last month eyed a faster timetable for raising interest rates this year, potentially as soon as in March, amid greater discomfort with high inflation. … Some officials also thought the Fed should start shrinking its $8.76 trillion portfolio of bonds and other assets relatively soon after beginning to raise rates, the minutes said.”
Obviously, inflation is a huge concern for the Fed, because in the opening months of 2022 it is now considering: 1) ending its quantitative easing bond-buying by March, 2) also in March, beginning to increase short-term interest rates, and 3) then quickly transitioning to reducing its massive balance sheet of Treasury holdings and mortgage-backed securities.
Nos. 1 and 2 mean the end of an accommodative Fed policy, and markets have been reacting to those expected (but accelerated) actions with a yawn. But No. 3 — reducing the Fed’s balance sheet — means actual tightening of the U.S. money supply, and the market wasn’t prepared to hear that.
This Bloomberg chart was from a May 20, 2021, article with the now-ironic headline “Don’t Fear the Taper: Fed to Dominate Treasury Market for Years.” The point of the article was that even after the Fed completes its tapering of bond buying, it would continue rolling over its massive holdings of Treasurys and continue surpressing longer-term interest rates.
In this chart, you can spot the last time the Fed began tapering an earlier quantitative easing, at the beginning of 2014. Note that the Fed’s balance sheet remained stable after the tapering for nearly four years. Actual reduction of the balance sheet began in 2018, and it wasn’t extreme, but it resulted in chaos in the bond and stock markets at the close of 2018, a year when the Fed also increased its federal funds rate four times. The S&P 500 fell nearly 15% from Dec. 1 to Dec. 24, 2018, and ended the month down nearly 10%.
So while Bloomberg was advising investors to not fear the Fed in May 2021, conditions are changing dramatically in 2022. And things could escalate this week with the release of the December 2021 inflation report, due out on Jan. 12 at 8:30 a.m. EST. Will the U.S. annual inflation rate rise to exceed 7.0%? It’s possible. (The consensus estimate is 7.1%, but these estimates have been very unreliable over the last 12 months.)
Here is how real and nominal interest rates have reacted over the last month:
Note that the real yield (meaning the yield compared to inflation) of a 5-year TIPS increased 30 basis points in a single week and the real yield of a 30-year TIPS could soon break through the zero barrier for the first time since May 2021. The real yield of a 10-year TIPS rose 25 basis points last week. These are significant moves higher.
But also notice that inflation breakeven rates have held fairly stable. The market is now pricing in future Fed actions to tamp down inflation, with a view that future inflation will average around 2.5% over the next decade.
What this means for TIPS and I Bonds
As real and nominal yields rise, you can expect the values of funds investing in TIPS and Treasurys to take a hit. Here are year-to-date total returns for three key funds (and realize that the year is only 5 market days old at this point):
Vanguard Total Bond Market ETF (BND): Total return of -1.40%.
Schwab’s U.S. TIPS ETF (SCHP): Total return of -2.23%.
Vanguard’s Short-Term TIPS (VTIP): Total return of -0.66%.
It looks likely that the 30-year TIPS real yield will rise above zero relatively soon, and that is also possible for the 5- and 10-year TIPS, but most likely much later in the year, if at all. Then again, look at the rate history of 2013, when real and nominal yields rose dramatically, even though the Fed took no actions that year except to say it planned to taper quantitative easing:
I created this chart for an article last month, speculating on the possibility of 10-year real yields rising above zero, which could cause the Treasury to increase the I Bond’s fixed rate at the May or November resets. I think that looks unlikely for May, but is a possibility in November, depending on how things play out.
If inflation eases, the pressure will be off the Fed to reduce its Treasury horde, and real yields could continue below zero for much of the year. However, if the Fed does increase its federal funds rate four times in 2022, I think it is likely that the 5-year TIPS yield could rise above zero.
If the 10-year nominal Treasury rises to a level near 2.50% (still relatively low by historic standards), the real yield of a 10-year TIPS should rise to close to zero, or above. Anything much higher and you could see the I Bond’s fixed rate rise, at some point in the future.
However, keep in mind that if the real yields of TIPS rise above zero, and the I Bond’s fixed rate remains at zero, then TIPS will again, finally, be a very competitive investment.
At any rate, my personal plan is to buy my I Bond 2022 allocation this month, to capture the current 7.12% variable rate for six months, and then the next rate, also likely to remain high, for another six months. That’s what I recommend, but many people will disagree, hoping for a higher fixed rate. I don’t think that will happen in May, at least. November could be interesting.
For TIPS investors looking to build out ladders into the future, an increase in real yields will make TIPS much more attractive. If you want to be a net buyer of TIPS, you want real yields to increase.
The Fed can change course
If the stock and bond markets take a frightening turn downward, expect the Fed to back off on a 4th interest rate increase this year, and a reduction in its Treasury balance sheet could be put off for months, maybe years. But the bond buying will end, either way. And short-term interest rates will go higher, either way.
The key will be the rate of U.S. inflation over coming months. It looks likely that high inflation will continue through March at least, before easing off to something closer to 4% for the rest of 2022. But inflation is impossible to predict. The Fed brought us this current surge in inflation. Will it have the courage to bring it under control?
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.
Treasury Inflation-Protected Securities 
Dongchen, I always say that the inflation breakeven rate reflects sentiment but is a fairly lousy predictor of future inflation.…