Treasury Inflation-Protected Securities

By David Enna, Tipswatch.com

If you follow the bond market at all, you know that longer-term nominal yields have been inching higher since the beginning of the year, and longer-term real yields (meaning yields above inflation) have been climbing, too. But the action has been primarily focused on the 10+-year maturities, and that means that the yield curve is steepening.

Here’s the trend in nominal yields:

• 4-week bill: Started the year at 0.09%, now at 0.03%, a decline of 6 basis points.
• 5-year note: Started the year at 0.36%, now at 0.59%, an increase of 17 basis points.
• 10-year note: Started the year at 0.93%, now at 1.37%, an increase of 44 basis points.
• 30-year bond: Started the year at 1.66%, now at 2.21%, an increase of 55 basis points.

And for real yields:

• 5-year TIPS: Started the year at -1.62%, now at -1.76%, a decrease of 14 basis points.
• 10-year TIPS: Started the year at -1.08%, now at -0.79%, an increase of 29 basis points.
• 30-year TIPS: Started the year at -0.39%, now at 0.08%, an increase of 47 basis points.

These moves higher in the longer terms are pretty dramatic in just two months, but at the same time, the shorter-term yields have actually declined. Here’s a chart comparing the Treasury’s real yield estimates for 5-, 10- and 30-year TIPS over the last 5+ years, with the simultaneous changes in the Federal Funds Rate during that period:

A couple of things are remarkably well demonstrated here: 1) Times of “easy money” (meaning times the Fed is holding short-term interest rates very low) tend to widen out the yield curve, and 2) times of tightening (when short-term interest rates are increasing) tend to flatten out the yield curve.

A flat yield curve, or the even more ominous inverted yield curve, is seen as an omen of upcoming economic distress. A widening yield curve, as we are seeing now, is considered a good omen for the economy. Certainly, talk in Congress of another $1.9 trillion in stimulus spending is having an effect on the longer yields.

The Federal Reserve has a lock on short-term interest rates, and Fed Chairman Jerome Powell made clear this week that very low short-term rates will continue well into the future. And he said he didn’t think increased stimulus spending would trigger higher inflation:

“Inflation dynamics do change over time but they don’t change on a dime, and so we don’t really see how a burst of fiscal support or spending that doesn’t last for many years would actually change those inflation dynamics.” …

But while the Fed can control short-term interest rates, it can only “influence” longer-term interest rates, which are much more market driven. The Fed is continuing asset purchases to stabilize the Treasury market, but hasn’t stepped up those efforts in 2021 as longer-term rates have been increasing.

And in fact, the Fed could be allowing longer-term rates to creep higher in an effort to cool speculation in stock and currency markets. From a MarketWatch report:

“The Fed is not bothered by the move and may be slow to fight it,” said Mark Cabana, head of U.S. rates strategy at BofA Global Research, in a Wednesday note. …

“It seems so far that what the Fed is viewing in the bond market as constructive,” said Padhraic Garvey, regional head of research for the Americas at ING, in an interview.

What this means for the TIPS market

If you are an investor in TIPS mutual funds or ETFs, you’ve probably seen the value of your holdings decline this year, after a very good performance in 2020. When real yields rise, the value of a TIPS declines. The TIPS universe includes only 46 total issues, and of those, 18 have maturities of 0 to 5 years, and 34 have maturities under 10 years.

So given the events of 2021 so far, you’d expect that a short-term TIPS ETF (like Vanguard’s VTIP, which holds 0-5 year maturities) to be outperforming a broad-based TIPS ETF (like iShare’s TIP, with 1-30 year maturities) or a longer-term TIPS ETF (like Pimco’s LTPZ, with TIPS of 15+ year maturities).

And that is what is happening, as this stock chart shows:

Will this trend continue?

Anything I say is pure speculation, okay? But yes, I think this trend could continue, as long as the Fed remains committed to holding short-term interest rates near zero, while also allowing the longer-term yields to climb higher.

No matter what happens in the rest of 2021, I think the Fed will resist the urge to force short-term interest rates higher. And if the pandemic wanes and the economy gradually improves, the Fed shouldn’t be overly worried as yields creep higher for longer-term bonds.

But what if the stock market hits a deep correction or even falls into a bear market? Then the Fed, as it always does, will attempt to come to the stock market’s rescue. And at that point it will try to force longer-term rates lower through aggressive bond buying. Just my opinion.

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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.

By David Enna, Tipswatch.com

The Treasury’s offering of a new 30-year TIPS auctioned Thursday to weak demand, generating an above-current-market real yield of -0.04%, about 6 basis points more than expected. Then, one day later, the Treasury’s estimate of 30-year real yield broke above zero, to 0.03%, rising above zero for the first time since June 9, 2020.

Here is that trend over the last year, up to Thursday’s market close:

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.

TIPS real yields have been negative to inflation, across all maturities, for about 8 months, so this move on Friday is significant. Investors are seeking higher nominal and real yields, especially in the long maturities. The nominal yield for the traditional 30-year Treasury bond also has been climbing, from 1.66% on Jan. 4, 2021, to 2.14% at the market close on Friday.

The TIPS that auctioned Thursday, CUSIP 912810SV1, got a coupon rate of 0.125%, so investors had to pay a premium, an adjusted price of about $105.01, because the real yield was below the coupon rate. As of Friday’s market close, the price on the secondary market had dropped to $103.06, a fall of nearly 2% in a single day. This demonstrates the volatility of 30-year Treasury issues.

The next TIPS auction, on March 18, will be for a reopened 10-year TIPS, CUSIP 91282CBF7, but 10-year real yields remain well below zero. As of Friday’s close, this TIPS was trading with a real yield of -0.82%. The originating auction on Jan. 21 got a real yield of -0.987%, so 10-year real yields are also climbing.

This is from a Reuters report after the market close Friday:

“The bond market’s trying to reprice the fact that the Treasury is going to borrow more money to pay for the stimulus package,” said Tom di Galoma, a managing director at Seaport Global Holdings in New York. …

Meanwhile, the 30-year TIPS yield, which had been in negative territory since June, surpassed the 0% mark, rising after a weak auction of $9 billion of the securities on Thursday. …

“It’s hard to build a fundamental case for 30-year TIPS yields to be negative forever,” said Jim Vogel, senior rates strategist at FHN Financial in Memphis, Tennessee. “Over 30 years, that’s a lot of Fed accommodation for a long time.”

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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.

By David Enna, Tipswatch.com

The U.S. Treasury’s auction of $9 billion in a new 30-year Treasury Inflation Protected Security, CUSIP 912810SV1, ended with a real yield to maturity of -0.04%, a bit higher than expected and a possible indication of weak demand for this issue.

The Treasury’s real yield estimate for a 30-year TIPS closed Wednesday at -0.11%, 7 basis points lower than this auction result. And just two hours before the auction close, a similar TIPS (29 years to maturity) was trading on the secondary market with a real yield of -0.10%. That yield has since increased to -0.06%. The bid-to-cover ratio for this auction was 2.31, also an indication of lukewarm demand.

Since the beginning of the year, real yields for this term of TIPS have risen more than 30 basis points, from -0.39% on January 4 to -0.04% at today’s auction.

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.

The Treasury set the coupon rate for CUSIP 912810SV1 at 0.125%, the lowest it will go for any TIPS. That is the lowest coupon rate in history for any 30-year TIPS. But it also means investors at today’s auction had to pay a premium for the higher-than-yield coupon rate, with an adjusted price of about $105.01 for about $100.08 of value, after accrued interest and inflation are added in. This TIPS has a settlement date of Feb. 26, 2021, when it will have an inflation index of 1.00037.

Here is the trend in the 30-year real yield over the last 12 months, showing the deep dive in yield after the pandemic outbreak in March 2020, and the gradual rise higher, which has accelerated in 2021:

Inflation breakeven rate

With a nominal 30-year Treasury bond now trading with a yield of 2.07%, this TIPS gets an inflation breakeven rate of 2.11%, which is in line with expectations. That means CUSIP 912810SV1 will outperform a nominal 30-year Treasury if inflation averages higher than 2.11% over the next 30 years.

Last year on Feb. 20, 2020, an identical 30-year TIPS auctioned with an inflation breakeven rate of 1.71% and reopened at auction on Aug. 20 with a breakeven rate of 1.65%. Inflation expectations are rising, and that makes this new TIPS more expensive versus a nominal Treasury. That could be one reason for the apparent lukewarm reaction to today’s auction. But 2.11% was still in line with 2018 auctions of this term.

Here is the trend in the 30-year inflation breakeven rate over the last year, showing the steady rise higher since the depths of pandemic-induced market turmoil in March 2020:

Reaction

It ended up that this new TIPS didn’t even come close to breaking the record for low yield for any 29- to 30-year TIPS at auction, -0.272%, set on Aug 20, 2020. But it is only the second 30-year TIPS auction in history to result in a negative real yield.

The TIP ETF had been trading lower all morning (indicating slightly higher yields) and then dipped lower again right after this auctions close at 1 p.m. EST. So the higher-than-expected yield came as a slight jolt to market, and indicates demand was not strong for a 30-year TIPS with a real yield negative to inflation.

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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.

By David Enna, Tipswatch.com

The U.S. Treasury on Thursday (Feb. 18, 2021) will auction $9 billion in a new 30-year TIPS, CUSIP 912810SV1. The coupon rate and real yield to maturity will be set by the auction results, but a couple things are nearly certain: 1) The coupon rate will be set at a record-low 0.125%, and 2) the real yield to maturity is likely to be negative to inflation.

Because my style of investing in TIPS is to buy and hold them to maturity, a 30-year TIPS has zero appeal for me. I have invested in them in the past, with maturities in 2029 (3.875% coupon rate) and 2041 (2.125% coupon rate). Those remain outstanding investments, but now that the new-issue maturity date has stretched out beyond my likely lifespan — 2051 — and real yields have dropped to negative levels, a 30-year TIPS doesn’t interest me.

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.

The U.S. Treasury is currently estimating the real yield of a full-term 30-year TIPS at -0.16%, which means an investor is willing to accept a return 0.16% less than official U.S. inflation over the next 30 years. That yield estimate has actually been rising recently, coming off a 2021 low of -0.39% on Jan. 4.

The lowest auctioned real yield for any 29- to 30-year TIPS was set last year, on Aug. 20, when a 29-year, 6-month TIPS got a real yield of -0.272%. That is the only auction of this term to ever get a negative real yield.

If Thursday’s auction result sets the real yield in the negative range, the Treasury will set the coupon rate of this TIPS at 0.125%, and investors will have to pay a premium, probably about $108.50 (or more) for $100 of par value in this TIPS.

To summarize, then, an investor interested in purchasing $10,000 of this TIPS will have to make an initial investment of about $10,850, and then will receive about $12.50 in interest payments a year, rising with inflation. The principal balance will also rise with inflation, for 30 years. The accrued principal (which is taxable in the current year it is accrued) can’t be touched until the TIPS matures or is sold. This is the reason a TIPS of this term, with this low a yield, should only be purchased in a tax deferred account.

Here is the trend over the last 5 years in the 30-year real yield, showing the dramatic drop in after-inflation returns since early 2019, and the dip into negative yields after the Federal Reserve began its bond-buying stimulus program in March:

30-year TIPS as trading investment

Because 30-year Treasurys (bonds or TIPS) are so volatile, many investors find them appealing for short-term trades. For example, a new 30-year TIPS issued a year ago, on Feb. 20, 2020, got a real yield of just 0.261% and a coupon rate of 0.250%, both of which look unattractive. But that TIPS — which auctioned with an adjusted price of about $99.64 — is now trading on the secondary market at $112.46, a gain of 12.5% in a year.

A small swing in yield for a 30-year Treasury can generate a large gain or loss in the short term. Traders just need to understand the risk. It’s not my thing. I have no opinion.

30-year inflation breakeven rate

With a 30-year Treasury bond trading with a nominal yield of 2.01%, this TIPS would get an inflation breakeven rate of 2.17% if it auctions with a real yield of -0.16%. That would be the highest breakeven rate for any auction of this term since October 2013, but breakevens were also near this level in 2018. A higher inflation breakeven rate indicates that a TIPS is becoming more “expensive” versus a nominal Treasury of the same term.

Here is the trend in the 30-year inflation breakeven rate over the last 5 years, showing the very strong rise in inflation expectations since the worst days of the pandemic in March 2020:

The obvious alternative: U.S. Series I Savings Bonds

Another Treasury issue, the U.S. Series I Savings Bond, also adjusts to official U.S. inflation but currently has a real yield of 0.0%, which is 16 basis points higher than a 30-year TIPS. (That spread is equal to nearly 5% in current value.) But the I Bond has other significant advantages: 1) a flexible maturity date of 1 year with a small penalty, or 5 to 30 years with no penalty, 2) tax-deferred interest payments, and 3) much better protection against future deflation.

When a 30-year TIPS has a negative real yield, the I Bond is a superior investment. Purchases are limited, however, to $10,000 per person per calendar year.

The Feb. 18 auction

Noncompetitive bids (like those made at a brokerage or Treasury Direct) close at noon on Feb. 18, and the auction ends at 1 p.m. I will be posting the results Thursday after the close.

Here’s a history of recent TIPS auctions of this term:

By David Enna, Tipswatch.com

I’ve been a big advocate of purchasing Treasury Inflation-Protected Securities over the last decade, and much of that time … I’ve been wrong.

Oops, sorry.

TIPS are investments that provide a market-based real return above (or below) inflation, and they can be directly compared with nominal Treasurys of the same term. The spread between the after-inflation (real) yield of a TIPS versus the nominal yield of a traditional Treasury is called the inflation breakeven rate.

For example:

• A 10-year Treasury note currently has a nominal yield of 1.15%.
• A 10-year TIPS currently has a real yield of -1.06%.
• Today’s 10-year inflation breakeven rate is 2.21%.

An investor looking at a 10-year TIPS as a buy-and-hold-to-maturity investment today needs to ask this question: Do I believe inflation will average more than 2.21% over the next 10 years? If the answer is yes, buy the TIPS. If the answer is no, buy the nominal 10-year.

(Actually, the better solution is to first buy U.S. Series I Bonds, up to the $10,000 per person per year limit. An I Bond purchased today has a real yield of 0.0%, which is a 106-basis-point advantage over a TIPS. And the I Bond’s inflation breakeven rate is only 1.15% versus the nominal U.S. Treasury. I Bonds are the superior investment.)

For much of the time over the last decade, inflation expectations — reflected in the 10-year inflation breakeven rate — have been running above 2.0%, like they are today. However, inflation over the last 10 years has only averaged 1.7%. So TIPS have been highly likely to underperform nominal U.S. Treasurys over the last decade.

This brings us to CUSIP 912828PP9, a 10-year Treasury that matured Jan. 15, 2021. It had an originating auction on Jan. 20, 2011, which generated a real yield to maturity of 1.17% and a coupon rate of 1.125%.

Today, we’d be jumping for joy over a real yield of 1.17% on a 10-year TIPS — and in fact I was a buyer at this auction and just hand this TIPS mature. Sad moment.

But this TIPS wasn’t a relatively great investment. Why? On the date of the auction 10 years ago, a 10-year nominal Treasury note had a nominal yield of 3.34%, creating an inflation breakeven rate of 2.17%, close to where we are today.

Here’s the bad news: U.S. inflation only averaged 1.7% over the last 10 years, meaning this TIPS under-performed a nominal Treasury by about 0.47% a year over 10 years. An investor would have done better by grabbing a 10-year Treasury note yielding 3.34%.

Putting this into perspective

A TIPS investment has the advantage of protecting against unexpectedly high future inflation, but will under-perform in times of unexpectedly low future inflation. We’ve just completed a decade of unexpectedly low inflation, with 10-year average rates running as low as 1.3% for the 10 years ending in January 2017.

In general, when the inflation breakeven rate has dipped well below 2.0%, TIPS have out-performed, because they became “cheap” versus a nominal Treasury.

We don’t know what the future will bring. The market expects higher inflation, and many people foresee inflation climbing into the 3% to 4% range. It could happen. Or, it won’t. We don’t know.

A lower inflation breakeven rate makes TIPS a more attractive investment versus a nominal Treasury. That’s the lesson of the last decade.

Here are the TIPS vs. nominal results for all 5- and 10-year TIPS that have matured over since 2013:

To view this at a glance, the annual variance number in the last column shows how the inflation breakeven rate compared to actual inflation. When the numbers are green, a TIPS was the superior investment. When they are red, the nominal Treasury was the better investment.

Inflation breakeven rates of less than 2.0% are noted in green. In general, TIPS out-perform nominal Treasurys when this happens. The 10-year TIPS that matured in July 2020 had only a rounding error (less than 0.1%) of difference.

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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.