Treasury Inflation-Protected Securities

By David Enna, Tipswatch.com

This article is the eighth in a series looking at how my three favorite bond funds — Vanguard Short-Term Inflation Protected (VTIP), Schwab U.S. TIPS (SCHP) and Vanguard’s Total Bond (BND) — performed after 2013, when the Fed signaled it would back off on bond purchases and eventually raise short-term interest rates.

Why do this? Because we may be heading into a similar scenario in 2022 and beyond, with the Fed tapering bond purchases and eventually (and gradually) raising short-term interest rates. The performance after 2013 could tell us a lot about what’s ahead.

To recap, here are the three bond funds I am tracking; they are three conservative, liquid, mainstream bond funds with very low expense ratios. Here’s a summary of their basic statistics and performance:

2020: A chaotic year of pandemic fears, stunning stimulus

Let’s recall that 2020 started off with U.S. investors fearing a coming recession. In 2019, the Federal Reserve had already cut its key short-term interest rate three times. The yield curve had flattened, and TIPS with terms up to 10 years already had real yields close to zero. On Jan. 24, 2020, a 10-year TIPS auctioned with a real yield of 0.03%, the lowest in seven years.

So the financial markets were already facing low-level chaos. It was about to get a lot worse. Global awareness of the COVID-19 pandemic began rising in January, but gradually. Between January 21 and February 23, 2020, 14 coronavirus cases were reported by U.S. health agencies. The first non-travel case was confirmed in California on Feb. 26, and the first U.S. death was reported on Feb. 29. By March 15, two weeks later, the U.S. had reported 3,485 cases and 65 deaths. One week later, on March 22, the case total rose to 34,000 and deaths reached 413.

The escalating pandemic caused full-out panic in the financial markets. The S&P 500 stock index fell about 25% in the three weeks from March 1 to March 20, plummeting into a bear market. Bond markets were roiled, with yields rising and falling in seemingly random patterns. The financial system was in severe stress.

The Federal Reserve stepped in quickly to calm the markets and Congress soon followed along with a series of historically massive stimulus packages, many of which remain in effect today. Here is a rough timeline of the stimulus pouring into the U.S. economy:

• March 3, 2020: The Federal Reserve cut its federal funds rate by 25 basis points, to a range of 1.00 – 1.25%.
• March 15: Federal Reserve met on Sunday to cut short-term interest rates 100 basis points (effectively to zero) and launched another round of “quantitative easing,” a $700 billion program of bond buying. “There’s no monthly cap, no weekly cap,” Fed Chair Jerome Powell said. “We’re going to go in strong starting tomorrow.”
• March 17: Federal Reserve created a Commercial Paper Funding Facility to protect short-term corporate debt.
• March 18: Federal Reserve created a Money Market Mutual Fund Liquidity Facility to protect funds investing in corporate debt.
• March 20: The Fed opened its money market program to include high-quality municipal debt.
• March 23: The Fed expanded its quantitative easing bond-buying to include mortgage-backed securities.
• March 23: The Fed created the Primary Market Corporate Credit Facility to buy corporate bonds.
• March 26: The New York Fed announced plans to buy corporate bonds and bond exchange-traded funds on the secondary market.
• March 27: President Trump signed into law the $2.3 billion CARES Act, providing a direct cash payment of $1,200 per person, plus $500 per child. It also provided an additional $600 unemployment benefit per week. The CARES Act also created a moratorium on evictions.
• April 6: The Fed announced the Main Street Business Lending Program, that would purchase $600 billion of debt from companies employing up to 10,000 workers or with revenues of less than $2.5 billion.
• April 6: The Fed announced a a new emergency lending facility, the Municipal Liquidity Facility, that would purchase $500 billion of debt from states and cities.
• April 24: Congress passed a $484 billion supplementary stimulus package, mostly to support the Payment Protection Program.
• Aug. 10: Trump, by executive order, extended a $400-per-week payment to those currently receiving unemployment payments.
• Dec. 27: Trump signed a $900 billion stimulus and relief bill that included direct payments of $600 per person, with some income limits. It also continued expanded unemployment benefits.
• March 11, 2021: President Biden signed the American Rescue Plan Act of 2021, a $1.9 trillion package that included direct cash payments of up to $1,400 for individuals earning less than $75,000 a year, plus $1,400 per dependent.

Stimulus. It works.

My focus in these articles is to track how our three bond ETFs — VTIP, SCHP and BND — performed in the period from 2013 to 2021, a time when at first the Federal Reserve was unwinding quantitative easing and ultra-low interest rates, and then a few years later, launching even bigger quantitative easing and returning to ultra-low interest rates.

But I can’t ignore noting that the S&P 500 had a total return of 18.22% in 2020, after falling deep into bear market territory in March.

For the bond market, the Fed actions (along with general market chaos) resulted in a deep decline in both real and nominal interest rates. Real yields took a deeper fall, as investors began realizing all this stimulus raised the specter of rising inflation:

All of this was “very good news” for the bond market (and especially TIPS) in a very bad year of locked-down life in the United States. Here is how our three funds performed, with the chart showing net asset value, excluding distributions:

Just like the stock market, the bond market took a beating in March 2020 as financial chaos set it. This is why the Federal Reserve stepped in (on March 15, a Sunday) to slash short-term interest rates to near zero. Four days later, the Treasury staged a reopening auction of a 10-year TIPS, CUSIP 912828Z37, that resulted in an inflation breakeven rate of 0.43%. That’s right, in mid-March 2020, investors expected inflation to run at 0.43% over the next 10 years. The real yield at that auction came in at 0.68%.

But things turned around quickly as stimulus poured into the system. By May 22, CUSIP 912828Z37 had another reopening auction and got a real yield of -0.47%, a drop of 115 basis points in 2 months. Its inflation breakeven rate was 1.14%. Things were clearly settling down as the Federal Reserve began aggressively buying bonds at a rate of $120 billion a month.

Inflation dipped in 2020 to an annual rate of 1.4%, which dampened the return of the TIPS funds, but rising inflation expectations gave those funds a boost in net asset value. Schwab’s U.S. TIPS ETF, SCHP, was easily the top performer of the year for this group, but both BND and the shorter-term and less-risky VTIP also had very good years.

Conclusion

Although 2020 ended up being an excellent year for both bond and stock investors, let’s hope we never have to relive a year like that. The Federal Reserve and Congress acted to stave off financial disaster, and we are living with the result of those actions today as U.S. inflation soars to 5.4%, a 12-year high.

The events of March 2020 stunned me. When the Federal Reserve announced a new wave of quantitative easing on March 15, my immediate reaction was that real yields for TIPS would be heading lower — probably deeply negative to inflation. And yet, four days later, a 10-year TIPS got an auctioned real yield of 0.68%, about 65 basis points higher than expected. This was financial panic in action. The Federal Reserve’s actions halted that panic and then my logic held true: a 10-year TIPS is now yielding -0.94%.

Coming tomorrow: A look at 2021 and beyond

• 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
• 2021 and beyond: What’s ahead for U.S. financial markets?

* * *

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.

By David Enna, Tipswatch.com

This article is the seventh in a series looking at how my three favorite bond funds — Vanguard Short-Term Inflation Protected (VTIP), Schwab U.S. TIPS (SCHP) and Vanguard’s Total Bond (BND) — performed after 2013, when the Fed signaled it would back off on bond purchases and eventually raise short-term interest rates.

Why do this? Because we may be heading into a similar scenario in 2022 and beyond, with the Fed tapering bond purchases and eventually (and gradually) raising short-term interest rates. The performance after 2013 could tell us a lot about what’s ahead.

To recap, here are the three bond funds I am tracking; they are three conservative, liquid, mainstream bond funds with very low expense ratios. Here’s a summary of their basic statistics and performance:

2019: The Fed cries ‘uncle’; bond investors celebrate

Something significant happened at the end of 2018: After the Federal Reserve raised short-term interest rates in December — for the fourth time that year — stock market investors threw a fit, with the S&P 500 plunging nearly 15% in the first three weeks of December. The Federal Reserve got the message: It was time to change course.

During years of stock market gains from 2013 through 2016, the Fed had acted slowly to raise short-term interest rates from a near-zero level, by 25 basis points in 2015 and and another 25 in 2016. This was after S&P 500’s total return gained 32.2% in 2013, 13.5% in 2014, 1.3% in 2015, and 12% in 2016. But in 2018, the stock market had a negative return, with the S&P’s total return falling by 4.6%. That is the only year in the 2013 to 2021 period that the stock market had a negative return.

So, what did the Federal Reserve do? Here are its actions to reduce its federal funds rate in 2019:

• July 31, 2019: Reduction of 25 basis points, to a range of 2.00 – 2.25%.
• Sept. 18, 2019: Reduction of 25 basis points, to a range of 1.75 to 2.00%
• Oct. 30, 2019: Reduction of 25 basis points, to a range of 150 to 1.75%

In addition, the Federal Reserve announced in October 2019 that it would relaunch “pseudo” quantitative easing, with plans to buy $60 billion of Treasury bills per month. The Fed claimed this wasn’t QE, but an attempt to add short-term liquidity to the market. “These operations have no material implications for the stance of monetary policy,” the Fed said in a statement.

And here is how the bond market reacted, with both real and nominal yields falling across all maturities:

The year 2019 set up a very good scenario for TIPS investors: Real yields were falling deeply, while inflation maintained at a brisk level of 2.3% for the year. That combination gives TIPS investors capital gains, combined with gains in inflation accruals. The overall bond market also benefited from fairly deep declines in nominal rates. Here is how the net asset value of our three funds performed 2019, not including distributions:

Vanguard’s short-term TIPS fund, VTIP, with its shorter duration, was the laggard in this group, but it still had a good one-year performance. When distributions are added in Vanguard’s total bond ETF, BND, was the best performer of the three, just edging out Schwab’s U.S. TIPS ETF.

All of that looks fantastic — and it is fantastic — except when you look at the total return of the S&P 500 in 2019, up a glorious 31.2%, easily overwhelming its paltry 4.6% decline in 2018. The Federal Reserve heard the stock market’s bellows of pain in December 2018, and responded with three cuts in short-term interest rates. The “easy money” game was on again.

Conclusion

It’s odd, but my memory of 2019 was that the U.S. economy was heading toward recession and the Federal Reserve was working feverishly to avoid that, slashing interest rates and launching some sort of Treasury-bill QE. But, in reality … inflation ran at an above-target 2.3% for the year, and U.S. GDP grew 2.2% for the year, a reasonable rate. The U.S. stock market had a total return of 31%. The bond market cranked out gains of nearly 9%. And all this happened while the Federal Reserve was easing monetary policy.

This was all very weird. Except … nowhere near as weird as what was coming in 2020.

Coming Tuesday: The June inflation report

Coming Wednesday: A look back at 2020

• 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?
• 2020: Chaotic year of pandemic fears, stunning stimulus
• 2021 and beyond: What’s ahead for U.S. financial markets?

* * *

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.

By David Enna, Tipswatch.com

This article is the sixth in a series looking at how my three favorite bond funds — Vanguard Short-Term Inflation Protected (VTIP), Schwab U.S. TIPS (SCHP) and Vanguard’s Total Bond (BND) — performed after 2013, when the Fed signaled it would back off on bond purchases and eventually raise short-term interest rates.

Why do this? Because we may be heading into a similar scenario in 2022 and beyond, with the Fed tapering bond purchases and eventually (and gradually) raising short-term interest rates. The performance after 2013 could tell us a lot about what’s ahead.

To recap, here are the three bond funds I am tracking; they are three conservative, liquid, mainstream bond funds with very low expense ratios. Here’s a summary of their basic statistics and performance:

2018: Did the Federal Reserve go too far?

Bond funds had a mediocre — but not disastrous — year in 2018, even with the Federal Reserve raising its key short-term interest rate, the federal funds rate, four times in the year. Here was the Fed’s rate-hiking schedule:

• March 21, 2018: Increase of 25 basis points, to a range of 1.50 – 1.75.%
• June 13, 2018: Increase of 25 basis points, to a range of 1.75 – 2.00%
• Sept. 26, 2018: Increase of 25 basis points, to a range of 2.00 – 2.25%
• Dec. 19, 2018: Increase of 25 basis points to a range of 2.25 – 2.50%

The December 19 increase was the last of a string of nine rate increases dating back to December 2015. At the time, a lot of financial experts (joined by a non-financial-expert U.S. president) criticized the final December increase as going too far, too fast. The financial markets went into a tailspin, as noted in this Dec. 20, 2018, report from The Guardian:

“The Dow Jones industrial average dropped 70 points after the announcement to finish the day down 1.49%, while the S&P 500 lost 39.2 points, or 1.54%. US stocks are on course for their biggest December decline since 1931, the depths of the Great Depression.

“The selling spread into Asian trade on Thursday, where the Nikkei in Tokyo was down 2.3% and the Hong Kong market was off 1.1%. In China, the Shanghai Composite was down 0.8%. …

“(President) Trump has waged a public campaign to halt further rate rises, a highly unusual move for a president, calling the increases ‘crazy’ and ‘foolish’ and arguing the Fed’s policy was’“the “biggest threat” to the US economy, larger than the administration’s trade dispute with China.’ “

The S&P 500 fell nearly 15% from December 1 to December 24 and ended the month down nearly 10%. Against that backdrop, the bond market looked relatively serene. Here are the statistics for 2018:

By the end of the year, the yield curve had completely flattened, screaming a warning of a future recession. On Dec. 31, the 4-week Treasury was yielding 2.44%, the 5-year, 2.51%, and the 10-year, 2.69%. Real yields had inverted, with the 5-year TIPS ending the year with a higher real yield than the 10-year, as this chart shows:

On Dec. 20, 2018, a 5-year TIPS reopening auction generated a real yield to maturity of 1.129%, the highest in nearly 10 years. That was one of the greatest auction bargains of the last decade. One year later, a TIPS reopening auction of the same term generated a real yield of just 0.02%.

Amid all this rate-hiking fury, all three of our ETFs lost in net asset value in 2018, despite a gentle rally toward the end of the year. Here is the trend in net asset value, which does not reflect fund distributions:

Vanguard’s short-term TIPS fund, VTIP, ended up being the best performer in both net asset value and total return, generating a positive total return of 0.56% in 2018. Inflation in 2018 ran at 1.9%, enough to keep TIPS competitive. Still, Schwab’s U.S. TIPS ETF was the loser for the year. The total bond market was nearly flat, benefiting from nominal bond yields topping 2% across all maturities at the end of the year.

Conclusion

December 2018 was the peak of the Federal Reserve’s “non-accommodative” policy, after allowing short-term interest rates to top out at about 2.5%. The bond market flattened, but didn’t implode. It was the stock market’s harsh reaction that pushed the Fed into a corner. And just keep this in mind: The S&P 500’s total return declined only about 4.5% in 2018, after rising about 21.7% in 2017. Once again, my long-held theory proved true: The Fed will act to protect the stock market.

Coming tomorrow: A look back to 2019

• 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’
• 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?

* * *

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.

By David Enna, Tipswatch.com

This article is the fifth in a series looking at how my three favorite bond funds — Vanguard Short-Term Inflation Protected (VTIP), Schwab U.S. TIPS (SCHP) and Vanguard’s Total Bond (BND) — performed after 2013, when the Fed signaled it would back off on bond purchases and eventually raise short-term interest rates.

Why do this? Because we may be heading into a similar scenario in 2022 and beyond, with the Fed tapering off bond purchases and eventually (and gradually) raising short-term interest rates. The performance after 2013 could tell us a lot about what’s ahead.

To recap, here are the three bond funds I am tracking; they are three conservative, liquid, mainstream bond funds with very low expense ratios. Here’s a summary of their basic statistics and performance:

2017: ‘The calm before the storm’

Looking back, 2017 was the final year of relative bond market stability in the post-2013 era of “winding down quantitative easing.” This was despite three — yes three! — increases in the Federal Reserve’s key short-term interest rate. They came like this:

• March 17, 2017: Increase of 25 basis points to a range of 0.75 – 1.00%
• June 14, 2017: Increase of 25 basis points to a range of 1.00 – 1.25%
• December 13, 2017: Increase of 25 basis points to a range of 1.25 – 1.50%

The result wasn’t a taper tantrum, like in 2013, but the bond market’s yield curve began to flatten, often considered an omen of economic recession. The theory is: Longer-term yields will rise along with short-term yields (which are set by the Fed) if the market sees solid economic growth in coming years. But the market in 2017 wasn’t seeing that, and its pessimism suppressed longer-term yields and led to a relatively benign year for the bond market.

Here was the year’s trend in 5- and 10-year real yields, which became dramatically tighter at the end of the year:

But really, very little happened in 2017. Yields across the board — nominal and real — stayed in attractive zones, with real yields solidly above zero and inflation breakeven rates running at a reasonable 2.0%. Here are the statistics for 2017:

Note that inflation ended 2017 at an annual rate of 2.1%, giving support to the Fed’s decision to gradually — and consistently — increase interest rates.

This was the beginning of a wonderful — and too brief — era when you could find money market accounts paying 1.5% and 5-year bank CDs paying up to 3%. It was also a year of relative peace in the bond market, even with Fed rate increases looming. This chart shows the trend in net asset value for our three funds, and although there was a lot of low-bore volatility, all three funds ended up for the year, even before distributions:

The flattening yield curve held down the potential of Vanguard’s short-term TIPS fund, VTIP. When you look at total return, the total bond market (represented by BND) performed the best, but SCHP also had a good year.

All of this was setting up a more dramatic bond market in 2018, when the Federal Reserve continued to raise interest rates … four times. While 2018 wasn’t a disastrous year, it broke a two-year trend of relative stability in the bond market.

Coming tomorrow: A look back at 2018

• 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
• 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?

* * *

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.