10-year TIPS reopening auction generates a real yield of -0.580%

Posted on March 18, 2021 by Tipswatch

By David Enna, Tipswatch.com

Reflecting a trend of both rising real yields and rising inflation expectations, the U.S. Treasury’s reopening auction today of a 10-year Treasury Inflation-Protected Security — CUSIP 91282CBF7 — generated a real yield to maturity of -0.580%, an expected result that was higher than recent yields for this term.

This TIPS was created in an originating auction on Jan. 21, 2021, with a record low real yield to maturity for this term, -0.987%. Today’s auction result was 38 basis points higher, a big move in just two months.

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

CUSIP 91282CBF7 carries a coupon rate of 0.125%, the lowest the Treasury will allow on a TIPS. Because the auctioned real yield to maturity was well below the coupon rate, buyers at today’s auction had to pay a premium price — about $107.62 for about $100.73 of value, after accrued inflation and interest is added in. This TIPS will have an inflation index of 1.00473 on the settlement date of March 31.

But today’s price was well below the $111.64 cost of the originating auction, which reflects the big increase in real yields over the last two months.

It looks like the auction went off as expected, in line with the trend of overall increases in both real and nominal yields. At mid-morning, CUSIP 91282CBF7 was trading on the secondary market with a real yield of -0.59%, close to the auction result. So, no surprises. However, the bid-to-cover ratio was 2.42, a middling number that reflects decent, but not strong, demand.

Here is the trend in 10-year real yields over the the last two years, showing the brief bounce higher a year ago during pandemic-related market turmoil, and then a deep decline amid economic gloom, and the gradual rise higher since the beginning of 2021 as COVID vaccines were rolled out and Congress approved economic stimulus packages:

This recent rise in yields is driving prices lower for broad-based TIPS mutual funds and ETFs. The TIP ETF is trading down about 0.6% today at a price of $124.81, indicating higher market yields. But today’s auction had little effect on the price, which indicates the result matched expectations.

Inflation breakeven rate

With a nominal 10-year Treasury trading at the auction close at 1.73%, this 9-year, 10-month TIPS gets an inflation breakeven rate of 2.31%, a big surge higher than numbers from similar auctions over the last year:

  • March 19, 2020: 0.43%
  • May 21, 2020: 1.14%
  • July 23, 2020: 1.52%
  • Sept. 17, 2020: 1.65%
  • Nov. 19, 2020: 1.72%
  • Jan. 21, 2021: 2.09%
  • March 18, 2021: 2.31%

Investors are “all-in” in committing to higher future U.S. inflation, given the Federal Reserve’s commitment to continued economic stimulus, combined with the lofty cash payments and credits to individuals included in the newest economic package passed by Congress. But these same forces are driving both nominal and real interest rates higher.

Inflation has been running at 1.7% over the last year, and has averaged 1.7% over the last 10 years. Will inflation move dramatically higher, as the market is predicting? It could happen, but I am thinking the 2.31% inflation breakeven reflected in this auction could be nearing a top, at least until we start to see actual higher inflation in the United States. Future inflation is nearly impossible to predict.

Here is the trend in the 10-year inflation breakeven rate over the last two years, showing the dramatic climb higher from the market depths of March 2020:

What’s ahead?

Today’s auction was the first of two reopenings for CUSIP 91282CBF7. The Treasury will offer another reopening in May, and then offer a new 10-year TIPS in July.

Next month’s offering will be a new 5-year TIPS, with the auction on Thursday, April 22.

Here’s a history of recent 9- to 10-year TIPS auctions:

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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.

Posted in Investing in TIPS | 3 Comments

Next up: 10-year TIPS will reopen at auction on March 18, one year after turmoil hit markets

Posted on March 13, 2021 by Tipswatch

By David Enna, Tipswatch.com

The U.S. Treasury will offer $13 billion in a March 18 auction reopening CUSIP 91282CBF7, creating a 9-year, 10-month Treasury Inflation-Protected Security. Real yields have been climbing recently, but are yields up enough to make this reopening an attractive investment?

I plan to take a look, but first …

Let’s look back one year

Thursday’s auction will mark the one-year anniversary of the strangest TIPS auction in history — March 19, 2020 — which came just as awareness of the COVID-19 pandemic was exploding across the United States. This was a reopening auction offering $12 billion in CUSIP 912828Z37, also a 9-year, 10-month TIPS.

At the time, the Federal Reserve had already begun lowering its key short-term interest rate and had announced plans for a launch of a new quantitative easing program to hold down Treasury yields. By any indication, Treasury yields across the board should have been plummeting. But instead, for a brief few days, the bond market was seized by near panic and Treasury yields skyrocketed.

The Saturday before this TIPS auction, when its real yield had climbed to 0.04% on the secondary market, I noted in my preview article:

“The U.S. stock and bond markets are covered in fog this morning. Investors are up in the air and it’s not safe for landing. …

In past times when the U.S. economy sank into distress, the Federal Reserve launched bond-buying programs that propped up U.S. Treasury prices, and sent yields plummeting. … So for a TIPS trader, there is potential for a quick capital gain if the 10-year TIPS yield falls 50 basis points or more, just to the level where it was (-0.57%) on March 6. …

“What about buy-and-hold TIPS investors? A real yield of around zero isn’t attractive, but it might be the best yield you’ll get for the remainder of 2020.”

Less than a week later, CUSIP 912828Z37 reopened at auction with a real yield of 0.680%, a mind-boggling explosion of 125 basis points in just 13 days. I called it a “gorgeous result” for investors. This surge in real yields happened very quickly, practically a matter of hours.

I didn’t end up buying that TIPS because I didn’t trust that the surging yield could hold through an auction. Instead, when I saw the TIP ETF drop to below $110 a share on March 18, I jumped in with an investment in Schwab’s ETF, SCHP. I sold it 40 days later for an 11% gain. (Reminder: I’m not a TIPS trader! But this was a very weird market moment.)

In the weeks and months after that auction on March 19, 2020, 10-year TIPS real yields did plummet, down to -0.25% by March 30, and eventually down to -1.08% on Jan. 4, 2021. And then a gradual rise began, spurred by positive trends in the U.S. economy.

Here is the trend in 10-year real yields over the last five years, showing the very brief spike higher than happened to coincide with the TIPS auction on March 19, 2020, and then the very sudden drop deeply negative to inflation:

So now, back to the present

Real and nominal yields have been climbing recently, reflecting positive U.S. trends toward limiting the effects of the COVID-19 virus and aggressive stimulus programs launched by Congress. The Treasury’s estimate of the real yield of a 10-year TIPS has increased from -1.06% on Jan. 28 to -0.62% as of the market’s close on March 12. That’s a jump of 44 basis points, and that’s significant.

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

CUSIP 91282CBF7, which is being reopened Thursday, currently trades on the secondary market and you can track its real yield in real time on Bloomberg’s Current Yields page. As of Friday’s market close, it was trading with a real yield to maturity of -0.65% and a cost of about $107.94 for $100 of par value. It is trading at a premium to par because the real yield of -0.65% is far below the coupon rate of 0.125%.

In addition, it will carry an inflation index of 1.00473 on the settlement date of March 21. This means that investors seeking to buy $10,000 in this TIPS will pay about $10,845 for about $10,047 of value, after the rate premium and accrued inflation are added in. (This could change before Thursday’s auction, of course.)

Inflation breakeven rate

With a nominal 10-year Treasury note currently yielding 1.62%, this TIPS as of Friday’s market close has an inflation breakeven rate of 2.27%, rather high, even by historical standards. It means this TIPS will out-perform a nominal Treasury if inflation averages more than 2.27% over the next 10 years. U.S. inflation is currently running at 1.7% and has averaged 1.7% over the last 10 years. So investors are bidding up TIPS prices in anticipation of higher future inflation.

I agree that higher U.S. inflation seems likely, but 2.27% over the next 10 years might be about right. At the best, this TIPS is fairly priced versus a nominal U.S. Treasury, and and the worst, it’s overpriced. It’s definitely not cheap.

Here is the trend in 10-year inflation breakeven rate over the last 5 years, showing the impressive move higher since the extremely negative outlook of March 2020. This chart clearly shows inflation expectations are at the highest levels of recent years:

Disclosure: I’m biased

I’m not buying TIPS in this current market, with yields deeply negative to inflation. I’d get interested in investing in 10-year TIPS when the real yield can at least rise higher than the 0.0% real yield offered by a U.S. Series I Savings Bond.

But that doesn’t mean TIPS are lousy investments, especially for buy-and-hold-to-maturity investors building multi-year ladders for future retirement income. If you are buying a consistent amount each year, adding a year 10 years out to the ladder, Thursday’s auction certainly looks a lot more attractive than 91282CBF7’s originating auction on Jan. 21, which generated a real yield of -0.987%, the lowest in history for 9- to 10-year TIPS auctions.

I will be posting the auction results soon after it closes at 1 p.m. EDT Thursday. Non-competitive bids need to be made before noon Thursday.

Here’s a history of recent 9- to 10-year TIPS auction, with the “gorgeous result” of March 19, 2020 highlighted:

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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.

Posted in Investing in TIPS | 4 Comments

February inflation rose 0.4%: What does it mean for TIPS and I Bonds?

Posted on March 10, 2021 by Tipswatch

By David Enna, Tipswatch.com

As expected, U.S. inflation surged 0.4% in February, triggered primarily by rising gasoline prices. But the overall February inflation report from the Bureau of Labor Statistics, released this morning, is a bag of mixed messages. One interesting detail is that offers some good-looking data for the next interest-rate adjustment for U.S. Series I Savings Bonds.

The BLS reported that the Consumer Price Index for All Urban Consumers increased 0.4% in February on a seasonally adjusted basis. Over the last 12 months, the all-items index increased 1.7%. Those numbers exactly matched the consensus forecasts.

But the core inflation numbers, which remove data for food and energy, came in at 0.1% for the month and 1.6% year over year, below the consensus estimates. So while gas prices are forcing overall inflation higher, core inflation continues to slumber along at a moderate level.

The BLS noted that gasoline prices surged 6.4% in February and accounted for more than half of the overall increase in CPI-U. Gasoline prices are now up 1.5% year over year, after falling deeply negative throughout 2020. Prices for fuel oil were also up a sharp 9.9%. The electricity and natural gas indexes also increased, and the energy index rose 3.9% over the month.

Food prices were up 0.2% in February and rose 3.6% over the last 12 months. The index for fresh fruits increased 1.8%, the largest increase in that index since March 2014. But the index for dairy and related products declined 0.2% in February after falling 0.4% the previous month.

Some other highlights from the report:

  • Apparel prices fell 0.7% and are now down 3.6% year over year.
  • The index for used cars and trucks dropped 0.9% in the month but is up 9.3% year over year.
  • Shelter costs increased 0.2% in the month and are up 1.5% for the year. But keep in mind that eviction moratoriums are holding down rent costs. That could change in coming months.
  • The cost of medical care services increased 0.5% and are up 3.0% year over year.
  • The index for airline fares continued to decline in February, falling 5.1% following a 3.2% decrease in January.

Here is the overall trend for all-items and core U.S. inflation over the last 12 months, showing the deep decline after the pandemic erupted in March 2020, and the gradual climb higher in all-items inflation, even as core inflation has remained relatively stable:

What does this mean 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 February, the BLS set the inflation index at 263.014, an increase of 0.55% over the January number.

For TIPS. February’s inflation report means that principal balances for all TIPS will increase 0.55% in April, following a 0.43% increase in March. This is welcome news for TIPS investors, but keep in mind that in this case, non-seasonal adjusted inflation was slightly outpacing adjusted inflation, and eventually those numbers will balance out over a year.

Here are the new April Inflation Indexes for all TIPS.

For I Bonds. The February report was the fifth in a six-month series that will set the future inflation-adjusted variable rate for U.S. Series I Savings Bonds. At this point, five months in, inflation has increased 1.05%, which translates to an annualized variable rate of 2.10%, higher than the current rate of 1.68%. Because gasoline prices are continuing to rise in March, we should see that variable rate climb even higher. But … inflation is highly unpredictable.

After the March inflation report, to be issued April 13, we will then know the I Bond’s new variable rate. I’ll have more to say about this after that report, but here’s a hint: I Bonds are going to be a very attractive investment in our current low-interest-rate environment. Could they get as popular as Bitcoin? Er …. no.

Here are the numbers, with one month remaining:

What does this mean for future interest rates?

The weaker-than-expected core inflation numbers give the Federal Reserve a lot of leeway to continue easy money policies, but those policies were going to continue anyway, no matter what this report said. I am expecting short-term interest rates to continue at near zero through 2021. Longer-term interest rates have been rising recently, but this report shouldn’t push them higher.

Inflation should rise at a higher pace in the next few months, as gas and other prices continue climbing, and the Fed knows this. It won’t be a surprise. Inflation numbers for March, April and May will be compared with very weak numbers from a year ago, so “surprisingly high” increases seem likely, and won’t actually be a surprise.

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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.

Posted in I Bond, Inflation, Investing in TIPS, Savings Bond | 7 Comments

Inflation expectations are soaring, with a short-term twist

Posted on March 7, 2021 by Tipswatch

By David Enna, Tipswatch.com

I’ve been writing about inflation and inflation breakeven rates for 10 years, and I’ve never seen anything quite like the picture presented by this chart, which shows the trend in the 5-year inflation breakeven rate over the last decade:

Inflation expectations are soaring, in a way that is historically unique.

So, what is this inflation breakeven rate? It is a measure of investor sentiment toward inflation, and it is calculated by subtracting the real yield of a Treasury Inflation Protected Security from the nominal yield of a U.S. Treasury of the same term. So, in the case of the 5-year inflation breakeven rate, the calculation goes like this:

  • Five-year nominal Treasury note yield = 0.79%.
  • Five-year TIPS real yield = -1.64%
  • 0.79% – (-1.64%) = 2.43%

So, the market is forecasting that U.S. inflation will run at 2.43% over the next five years, the highest rate of market-predicted inflation since the 5-year breakeven rate hit 2.63% on July 7, 2008. That was just before the housing market crash sent stock values plummeting. Five months later, on Nov. 28, 2008, the 5-year breakeven fell to -2.24%, a remarkable crash of 487 basis points.

U.S. inflation is currently running at 1.4% and has been consistently below 2.0% since March 2020. Economists are predicting that the year-over-year number will rise to 1.7% with the February inflation report, to be issued at 8:30 a.m. EST Wednesday. That’s still a long way from an average of 2.43% over five years, but investors seem to be taking the Federal Reserve at its word when it says it is willing to force U.S. inflation above 2.0% and let it remain there for a period of time.

Still, the market-determined inflation breakeven rate measures sentiment and should not be viewed as an accurate prediction. In fact, the market often does a lousy job of predicting future inflation. The fact is, over the last decade, investors have been betting on higher inflation than actually resulted, and that has led to TIPS (in general) under-performing nominal Treasuries of the same term.

Inflation higher in the short term?

One interesting aspect of this sudden inflation mania is that is is focused more on the short term (meaning 5 years out) instead of the longer term (10 to 30 years out). The logic here, I assume, is the combination of massive fiscal stimulus from Congress, along with a Fed committed to easy-money policies well into the future.

Both real and nominal yields have been on the rise since February 1, but nominal yields are rising faster than real yields, and real yields in the shorter term have been fairly stable. And that is how you get a soaring inflation breakeven rate. Here are the numbers comparing the market yields on February 1 versus March 5:

This chart indicates that shorter-term TIPS should have been the best performing Treasury investment over the last month, and that’s true, with the Vanguard’s 0-5 year TIPS ETF (VTIP) gaining 0.33% since February 1, while the broad-based TIP ETF was down 1.93% and overall bond market (BND) was down 2.54%.

Can the inflation breakeven rate signal trouble?

Of course, no one is cheering for strongly higher future inflation, but a strongly higher inflation breakeven rate does indicate that TIPS overall are starting to get “pricey” versus nominal Treasurys. An inflation breakeven rate over 2.5% is expensive for the TIPS investor.

As the TIPS versus nominals chart showed, TIPS usually under-perform nominal Treasurys when inflation expectations get very high, in anticipation of higher inflation that never arrives.

At this point, we don’t know where inflation is heading, but my gut says it should be going higher. And yet, that is what my gut has been telling me for a decade. Must of been heartburn instead of an omen.

Buying TIPS and I Bonds provides insurance against unexpected future inflation. Although we haven’t needed that insurance over the last decade, I still like the idea of insurance.

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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.

Posted in Inflation, Investing in TIPS | 9 Comments

Could rising real yields cause the Treasury to raise the I Bond’s fixed rate above 0.0%?

Posted on March 3, 2021 by Tipswatch

By David Enna, Tipswatch.com

There’s been a lively discussion going on over at the Bogleheads forum about the possibility that the recent rise in real yields could prompt the Treasury to raise the fixed rate on the Series I Savings Bond above its current 0.0%. And that leads to the question: “Should I buy I Bonds now, or wait until later in the year?”

The correct answer is: “It doesn’t matter.” The Treasury will reset the I Bond’s fixed rate on May 1 and then again on November 1. I’d say with 99% certainty that the fixed rate will remain at 0.0% in the May reset, and it’s “highly likely” it will stay at 0.0% in November. I already bought my full 2021 I Bond allocation — in January — because I had a maturing TIPS that provided the needed cash.

Want to know more about I Bonds? Check out the Q&A at the bottom of my “Tracking Inflation and I Bonds” page.

I Bonds purchased today through April 30 will carry that permanent fixed rate of 0.0% and a six-month inflation-adjusted variable rate of 1.68%. Both the fixed rate and the inflation rate will be reset on May 1. I’m predicting the fixed rate will stay at 0.0%, and the inflation rate should be somewhere close to the current 1.68%.

The reset of the inflation-adjusted rate will be determined by official U.S. inflation from September 2020 to March 2021. As of the January inflation report, inflation was running at 0.50%, with two months remaining in the rate-setting period. That translates a variable rate of 1.0%, with two months remaining. Here are the numbers:

Because gas prices have been rising recently, it looks likely that inflation is going to be moderate to moderate-high over the next two months. That should push the inflation rate up to at least the 0.80% to 1.00% range, which translates to an I Bond variable rate of 1.6% to 2.0%. It could even be higher, but guessing future inflation is a loser’s game.

Anyway, the current variable rate of 1.68% is highly attractive given near-zero interest rates for safe investments of up to five years (you can’t find bank CDs or Treasurys anywhere close to that), and the new rate coming in May should also be attractive. If you buy an I Bond today, you’d get the 1.68% annualized rate for six months, then the next annualized rate for six months. My personal opinion: Buy anytime before May 1, but it’s not going to make a huge difference.

But could the fixed rate rise on May 1?

Short answer: No. The Treasury isn’t going to raise the fixed rate of an I Bond above 0.0% as long as the real yields of 5-year and 10-year TIPS are deeply negative. Here are the Treasury’s real yield estimates at today’s market close:

Understand that the I Bond’s fixed rate of 0.0% is equivalent to its “real yield to maturity.” In other words, it will almost exactly match official U.S. inflation for as long as you hold the I Bond. Therefore it has an 172-basis-point advantage over a 5-year TIPS and a 74-basis-point advantage over a 10-year TIPS. Those are huge advantages, equivalent to 8.6% of the value of a 5-year TIPS and 7.4% of the value of a 10-year TIPS.

Because the Federal Reserve is committed to holding short-term nominal rates near zero for more than a year in the future, and may step in to knock down longer-term nominal yields, it’s not likely that real yields in the 5- to 10-year range can climb above 0.0% in 2021. So I think the I Bond’s fixed rate will stay at 0.0%, at least through May 2022.

Take a look at this chart comparing the I Bond fixed-rate resets with the current 5- and 10-year TIPS yields just before the change. I’ve highlighted all the times the Treasury set the fixed rate at 0.1%. In every one of those times, the 10-year real yield was above 0.0%. There are instances where the 5-year TIPS yield was below 0.0%, but nowhere near the current -1.72%.

However, the Treasury does do odd things at times, so I am not 100% certain. But keep this in mind: If the Treasury raises the I Bond’s fixed rate to 0.1%, that is the equivalent of $10 a year on a $10,000 investment. It is no big deal. But I totally understand the desire of I Bond investors to fret about that fixed rate, because of psychology. We want the best possible investment, and a higher fixed rate is better than a lower fixed rate, even if just $10 is at stake.

Let’s say the Treasury goes nuts and raises the I Bond’s fixed rate to 0.50% on November 1. I would celebrate, even though I have already bought my 2021 allocation of $10,000 per person per calendar year. Why? Because in January, I’d be able to snag that 0.50% fixed rate with my 2022 allocation.

So, wait or not wait to buy I Bonds? It won’t matter much. I will address this topic again late in April, after the new variable rate is set by the March inflation report. The key thing is: Buy them every year, up to the maximum or whatever level you can afford. Because of the $10,000 purchase limit, it takes years to build a sizable holding of I Bonds.

Could the Treasury set a negative fixed rate?

The Treasury does not reveal how it sets the I Bond’s fixed rate and there is no apparent formula. The evidence suggests they at least look at the 10-year TIPS real yield, but there’s no precise calculation. This has led to speculation — including by me — that the Treasury could consider setting a negative fixed rate, letting it drop below 0.0%. It has never done this, but I couldn’t find any wording on the Treasury site that guarantees this. This is the Treasury’s totally vague explanation:

Treasury announces the fixed rate for I bonds every six months (on the first business day in May and on the first business day in November). That fixed rate then applies to all I bonds issued during the next six months. The fixed rate is an annual rate. Compounding is semiannual.

But … one of the Bogleheads heros, HueyLD, solved this vagueness by finding very specific language in the Federal Register that states the I Bond’s fixed rate can never drop below 0.0%, and that its composite rate can also never drop below 0.0%, even in a time of severe deflation.

Click here to read the full citation. From that text:

The (Treasury) Secretary, or the Secretary’s designee, determines the fixed rate of return. The fixed rate is established for the life of the bond. The fixed rate will always be greater than or equal to 0.00%. The most recently announced fixed rate is only for bonds purchased during the six months following the announcement, or for any other period of time announced by the Secretary.

… Composite rates are single, annual interest rates that reflect the combined effects of the fixed rate and the semiannual inflation rate. The composite rate will always be greater than or equal to 0.00%.

So, at least that issue is settled. The I Bond’s fixed rate, under current regulations, cannot go below 0.0%, even when other real yields have fallen deeply negative. And that means that I Bonds remain the world’s best inflation-protected investment in March 2021.

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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 recommends 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, Savings Bond | 10 Comments