Treasury Inflation-Protected Securities

By David Enna, Tipswatch.com

TIPS auctions are almost always on a Thursday, but that won’t happen next week, because Thursday is Christmas Eve, which this year only is a federal holiday thanks to an executive order by President Trump.

So the U.S. Treasury will instead stage its reopening auction for $15 billion of CUSIP 91282CAQ4 on Tuesday, Dec. 22, creating a 4-year, 10-month TIPS. This TIPS was born in an originating auction on Oct. 22, when it generated a real yield to maturity of -1.32%. The coupon rate was set at 0.125%, the lowest the Treasury will go for any TIPS.

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 price of a TIPS is adjusted to reflect how much the real yield is above or below the coupon rate.

In the originating auction on Oct. 22, investors had to pay a large premium to collect the coupon rate of 0.125%. The adjusted price was about $107.59 for about $100.20 of value, after accrued inflation and interest are added in.

Next week’s auction is likely to carry an even higher premium price. This TIPS trades on the secondary market, so you can track its real yield and price on Bloomberg’s Current Yields page, which updates in real time when the market is open. As of about 10:20 a.m. today, this TIPS had a real yield to maturity of -1.58% and a price of about $108.58 for $100 of par value.

If that price holds through Tuesday’s auction, it will be the lowest real yield ever recorded in a 4- to 5-year TIPS auction. The current record is -1.496% from a reopening auction on Dec. 20, 2012. Just a year ago, on Dec. 19, 2019, a TIPS reopening of the same term got a real yield of 0.02%, a remarkable 160 basis points higher than the current yield for the same term of TIPS.

(In addition, this TIPS will carry an inflation index of 1.00352 on the settlement date of Dec. 31, so investors will pay a slightly higher price and receive a matching amount of additional principal.)

Here is the trend in 5-year real yields over the last five years, showing the deep drop in yield after the Federal Reserve began lowering interest rates and buying Treasury securities amid the pandemic panic of mid-March 2020:

Inflation breakeven rate

With a 5-year nominal Treasury note now trading with a real yield of 0.35%, this TIPS currently has an inflation breakeven rate of 1.94%, a bit higher than recent trends. This indicates that investors are now anticipating higher future inflation. (U.S. inflation is currently running at 1.2% and has averaged 1.7% over the last five years.) Inflation will have to average higher than 1.58% for investors to get any nominal return at all from this TIPS.

A higher inflation breakeven rate indicates that a TIPS is getting more expensive versus a nominal Treasury of the same term. The best you could say is that this TIPS is now “fairly priced”; it certainly isn’t cheap.

Here is the trend in the 5-year inflation breakeven rate over the last five years, showing the steep climb higher after the Federal Reserve stepped into Treasury markets in mid-March:

The obvious alternatives

This 5-year TIPS is looking highly unattractive, possibly setting a record low yield and carrying a very high premium price (likely around 8% above par) for a 0.125% coupon rate, plus inflation adjustments. One good thing, though, is that the term is only 4 years, 10 months, the shortest term currently offered in TIPS auctions.

Better alternatives:

Series I Savings Bond. I Bonds currently offer a real yield of 0.0%; in other words they will exactly match future inflation with no risk of loss during deflationary periods. This means the the I Bond has a 158-basis-point advantage over this offering of a TIPS reopening. I Bonds have zero duration risk, and can be redeemed after 1 year with a small penalty and after 5 years with no penalty. But … purchases are limited to $10,000 per person per calendar year. It takes multi-year effort to build up an asset allocation in I Bonds.

Even if you have already purchased up to the limit in 2020, in January you get a new purchase cap and can again invest in I Bonds up to the cap. I Bonds are the best inflation-protected investment right now.

5-year bank CD. Best-in-nation 5-year bank CDs are currently offering insured nominal yields around 0.90%, which boost the inflation breakeven rate of this TIPS to a daunting 2.48%. Think inflation will average higher than 2.5% over the next five years? But the TIPS. Think it will be lower? Buy the 5-year bank CD.

I think most people, though, would opt for a shorter-term CD. Best-in-nation one-year bank CDs currently have nominal yields around 0.6%. That’s lousy, but safe and will beat your money market’s return of around 0.05%.

Auction details

Tuesday’s auction will operate on the normal schedule, with noncompetitive bids due by noon EST and the auction will close at 1 p.m. I hope to post the results soon after the auction’s close.

Here is a history of all 4- to 5-year TIPS auctions back to 2012:

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.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 1.2%.

Both the 0.2% increase in monthly inflation and the 1.2% increase in year-over-year inflation were higher than the consensus estimates. Core inflation, however, which strips out food and energy, matched the consensus estimate of 0.2% for the month and 1.6% year over year.

The BLS said the month’s inflation was broad based, with no one sector dominating the results. Food prices dropped 0.1% for the month, but remain up 3.7% over the last year. Gasoline prices, often a key factor in monthly inflation, dropped 0.4% for the month. Gas prices are down 19.3% over the last year.

Apparel prices were up a sharp 0.9%, and costs of transportation services were up an even higher 1.8%. The index for airline fares rose 3.5% in November after increasing 6.3% in October. Airlines took advantage of a bump in holiday travel, but this trend could begin reversing as pandemic lockdowns begin taking effect across the nation.

Here’s a look at the one-year trend in rates for all-items and core inflation, showing the gradual rise higher and then stabilization after the economic turmoil of February and March:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bond 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. The BLS set the November inflation index at 260.229, a decline of 0.06% from the October number.

For TIPS. The new November inflation index means that principal balances for all TIPS will be adjusted 0.06% lower in January 2021 after rising 0.04% in December. In essence, TIPS are losing a very small amount of principal over the two months. Here are the new January Inflation Indexes for all TIPS.

For I Bonds. The November inflation number is the second of a six-month string that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on May 1, 2021. After two months, inflation has been running at -0.02%, which would translate to a variable rate of -0.04%. A lot can happen in the next six months, so this shouldn’t concern I Bond investors. Not yet, at least.

We saw a similar pattern in 2019, when non-seasonally adjusted inflation fell 0.05% in November and 0.09% in December, but then rebounded higher in the next three months. That pattern was even more dramatic in 2018, when inflation fell 0.33% in November and 0.32% in December, then rebounded higher.

Here are the inflation data so far for this rate-setting period:

You can see this data going back to 2012 on my Tracking Inflation and I Bonds page.

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.

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The Treasury’s offering of $12 billion in a reopened 10-year Treasury Inflation-Protected Security resulted in a real yield to maturity of -0.867%.

This is CUSIP 912828ZZ6 and the auction creates a 9-year, 8 month TIPS, with an already existing coupon rate of 0.125%, the lowest possible for a TIPS. That means buyers at today’s auction had to pay a premium price of about $111.64 for about $101.51 of value, after accrued inflation is added in.

The auction had a bid to cover ratio of 2.71, a sign of reasonably strong demand for this TIPS.

The inflation breakeven rate came in at about 1.72%, higher than recent results for auctions of this term.

Summary

• The Treasury will reopen CUSIP 912828ZZ6 on Thursday, creating a 9-year, 8-month TIPS.
• The current market for this TIPS shows it with a real yield (after inflation) to maturity of -0.85% and a price of about $109.85 for $100 of par value.
• The inflation breakeven rate is currently about 1.74%, which looks fair.

The U.S. Treasury will reopen CUSIP 912828ZZ6 at auction Thursday, creating a 9-year, 8-month Treasury Inflation-Protected Security. Although market conditions have improved slightly for a TIPS of this term, I don’t think many small-scale investors are going to find it attractive.

Read my full analysis on SeekingAlpha.com