Treasury Inflation-Protected Securities (2024)

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Posted on December 21, 2023 by Tipswatch

By David Enna, Tipswatch.com

There were no surprises in today’s Treasury reopening auction of $20 billion in CUSIP 91282CJH5, creating a 4-year, 10-month Treasury Inflation-Protected Security.

The real yield to maturity came in at 1.710%, which exactly matched the when-issued prediction used by bond traders. In the hours before this auction, this TIPS was trading on the secondary market with a real yield of 1.69%, so today’s investors got a 2-basis-point boost.

Definition: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 each year until maturity.

In its originating auction on Oct. 19, 2023, CUSIP 91282CJH5 got a real yield to maturity of 2.440% and its coupon rate was set at 2.375%, the highest for any 5-year TIPS since the very first TIPS auction of this term in history, which generated a coupon rate of 3.625% on July 9, 1997. Market conditions have changed dramatically in the last two months, as shown by the 1.710% real yield generated by today’s auction.

While 1.710% was well below the October auction’s real yield, it remains high by historical standards, as shown in this chart of real yields over the last 5 years:

Pricing

Because the auctioned real yield of 1.710% fell well below the coupon rate of 2.375%, investors had to pay a premium for this TIPS. This is how the Treasury reported the auction results:

The unadjusted price was 103.046880 and the inflation index will be 1.00453 on the settlement date of December 29. Let’s look at the cost of a investment of $10,000 par value for this TIPS at today’s auction:

• Par value: $10,000
• Coupon rate: 2.375%
• Auctioned real yield: 1.710%
• Adjusted principal: $10,000 par x 1.00453 = $10,045.30
• Unadjusted price: 103.046880
• Cost of investment: $10,045.30 x 1.03046880 = $10,351.37
• Plus, accrued interest of about $48.88

In summary, an investor who purchased $10,000 par value paid $10,351.37 for $10,045.30 in principal and will now collect future inflation accruals and a coupon rate of 2.375% on the principal balance until maturity on Oct. 15, 2028.

Inflation breakeven rate

With the 5-year Treasury note trading with a nominal yield of 3.87% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.16%, much lower than results for this maturity in recent auctions. The market is now pricing inflation through the next five years very close to the Federal Reserve target of 2%. Which raises the question: Is the market crazy?

Whatever happens over the next 4 years, 10 months, investors in CUSIP 91282CJH5 at today’s auction got a low-risk, appealing result, especially versus the 5-year nominal Treasury.

Reaction to the auction

It looks like the auction went off almost exactly as expected. The bid-to-cover ratio was 2.55, indicating decent demand. The TIP ETF, which holds the full range of maturities, barely budged after the auction’s close. Everything points to a ho-hum result.

I’ve noted in recent posts that we seem to entering a new era for Treasury yields, with somewhat lower yields likely over the next several months. At the least, yields should stabilize at current levels until the Federal Reserve reveals more exact information on its future moves.

This was the last TIPS auction of 2023. Later this month I will write a recap of the year in inflation protection, including I Bonds. The next TIPS auction will be Jan. 18, 2024, with the release of a new 10-year TIPS.

Here is the history of CUSIP 91282CJH5, which at its originating auction generated a real yield of 2.440%, the highest for this term in 15 years.

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• Upcoming schedule of TIPS auctions

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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. Please stay on topic and avoid political tirades.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

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Posted in Investing in TIPS|Tagged bonds, fixed-income, investing, markets, personal-finance|26 Comments

Posted on December 17, 2023 by Tipswatch

By David Enna, Tipswatch.com

The Treasury on Thursday will offer $20 billion in a reopened 5-year TIPS, CUSIP 91282CJH5, creating a 4-year, 10 month Treasury Inflation-Protected Security.

The TIPS to be reopened, CUSIP 91282CJH5, trades on the secondary market and could have been nabbed by investors just a month ago with a real yield to maturity of 2.37%. At Friday’s close, according to Bloomberg Yields Curve, that yield has now fallen to 1.73%. That’s a drop of 64 basis points in one month. Incredible.

And continued volatility is likely next week, right up to the auction’s close at 1 p.m. EST Thursday.

How attractive is this TIPS?

While a real yield of 1.73% seems suddenly disappointing, it is still attractive by historical standards. It could be the third or fourth highest yield for any auction of this term going back to October 2008, 48 auctions ago. Just look at the auction history for 5-year TIPS over the last year:

• Dec. 22, 2022, reopening, real yield of 1.504%
• April 20, 2023, new issue, real yield of 1.320%
• June 22, 2023, reopening, real yield of 1.832%
• Oct. 19, 2023, new issue, real yield of 2.440%

A real yield of 1.73% fits into this mix, but of course we’d all love to have bought heavily on Oct. 19 when the above-inflation yield hit 2.440%. (If you recall, this was actually a disappointing result for many investors. How times have changed!)

Here is the five-year trend in the 5-year real yield, showing that the current yield remains attractive by comparison to years of severely depressed rates:

Pricing for CUSIP 91282CJH5

If we assume that this TIPS will auction with a real yield of 1.73% (things will change, but let’s assume) then it will get a price of about 102.98, according to the Bloomberg data. Why so high? Because this TIPS has a coupon rate of 2.375% — set by that Oct. 19 auction — well above the current market real yield. It will also have an inflation index of 1.00453 on the settlement date of Dec. 29.

With that information, we can speculate on the pricing, using a purchase of $10,000 par as an example:

• Par value: $10,000.
• Adjusted principal on settlement date = $10,000 x 1.00453 = $10,045.30
• Cost of investment = $10,045.30 x 1.0298 = $10,344.65
• Plus, accrued interest, probably about $49.

So, in summary, an investor purchasing $10,000 par at Thursday’s auction will pay about $10,345 for $10,045 of principal and then receive inflation accruals and a coupon rate of 2.375% through the maturity date of Oct. 15, 2028.

This is a similar price to what you would pay on the secondary market, of course. On Saturday morning Vanguard was showing an ask price of 102.98 and a real yield of 1..73%, right in line with the Bloomberg data. But come Monday, things will change.

Inflation breakeven rate

With a 5-year nominal Treasury yielding 3.91%, this TIPS currently has an inflation breakeven rate of 2.18%, well below recent auctions of this term. That is a plus for investors. It means this TIPS will outperform the nominal Treasury if inflation averages more than 2.18% over the next 4 years, 10 months. Over the last 5 years, inflation has averaged 4.0%.

Here is the trend in the 5-year inflation breakeven rate over the last five years:

Final thoughts

I won’t be a buyer because my TIPS ladder is fully loaded with 2028 maturities.

I know from feedback from readers that this particular TIPS won’t be attractive to many, either at auction or on the secondary market. Why? Because it will carry a premium price and additional principal. And a lot of investors don’t find that appealing. Does it really matter? Probably not. And sitting on the sidelines could just mean facing lower real yields in the near future. It’s a dilemma.

In the last two days, I have been tempted to say that the bond market is over-reacting to the Fed’s potential actions. The Fed, in theory, will cut short-term interest rates by 75 basis points next year. (The market thinks the cuts will be much more substantial.) The Fed is NOT launching quantitative easing and in fact will continue tightening through 2024 by reducing its balance sheet.

Future short-term rates shouldn’t have a great effect on current mid- to longer-term Treasurys. The 10-year TIPS yield has fallen 35 basis points in four days. Why? That is a real question for the markets to consider.

Plus, the Treasury next year will continue ramping up auction sizes. In fact, Thursday’s reopening auction is for $20 billion, the highest in history for an 5-year TIPS reopening. Consider this: As of this week, the U.S. public debt stood at $33.8 trillion. One year ago it was $31.3 trillion. That is an increase of 8%. How far can Treasury yields really fall?

So the Treasury market has a lot to work out. Meanwhile, I will be posting the auction results soon after the 1 p.m. ET close on Thursday. Here’s a history of recent auctions of this term:

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• Upcoming schedule of TIPS auctions

* * *

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. Please stay on topic and avoid political tirades.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Federal Reserve, Inflation, Investing in TIPS|23 Comments

Posted on December 14, 2023 by Tipswatch

By David Enna, Tipswatch.com

We’ve entered a new era. That’s what Bloomberg’s ever-thoughtful Tom Keene repeated over and over in Wednesday’s coverage of the Federal Reserve’s interest rate forecasts. “This is a sea change,” he said. “I have to emphasize how important this is.”

What exactly did the Fed do? It held the federal funds rate at the current level (target range of 5.25% – 5.50%) and signaled strongly that it is likely to cut short-term interest rates three times in 2024, beginning as early as March. This wasn’t unexpected, but the Fed was unusually firm in declaring that we’ve entered a new dovish era of interest rates, after nearly two years of unprecedented increases.

The Fed projections settled on 75-basis-points of rate cuts in 2024, but the stock and bond markets clearly anticipate something larger. Both markets soared Wednesday and into Thursday, with the Dow average hitting an all-time high and bond yields falling dramatically.

Significantly, however, the FOMC also reiterated its intention to continue lowering its massive balance sheet of U.S. Treasurys. It said:

In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

This is an important tidbit of news, because it means that while the Fed will be easing on the short-end of the yield curve, it will continue tightening on the longer end by allowing Treasurys to mature and roll off the balance sheet. That is quantitative tightening, and it should support longer-term yields.

As a result, you should see a widening of the yield curve, with yields on shorter maturities falling, but rising or holding stable for longer maturities (or at least not falling as far). This was immediately evident in the way the Fed action rocked Treasury real yields:

I created this chart at about 9:10 am ET and 15 minutes later the 5-year real yield had fallen to 1.74% and the 10-year to 1.72%. There’s no way to say exactly how far this could go. But it is significant because the Treasury will be auctioning a reopened 5-year TIPS on Dec. 21 and then a new 10-year TIPS on Jan. 18, 2024. Both of those auctions could result in much lower real yields than we have seen in recent months.

The “sea change” nature of the Fed’s pronouncements can’t be underestimated. This morning, the U.S. dollar index is trading at 102.14, down about 2% since the Fed’s announcement at 2 p.m. Wednesday. A fall in the value of the dollar has an inflationary effect, especially on commodities. So it shouldn’t be a surprise that crude oil prices are up 3% this morning.

What this means for TIPS

I don’t think the Fed’s action is dire news, but it will mean lower real yields on near-future TIPS investments. We aren’t heading anywhere near the negative-real-yield fiascos of the recent past. And if the Fed continues lowering its balance sheet, the yield curve should steepen, making longer-term TIPS relatively more attractive.

The Fed must be fairly confident that inflation is indeed tamed, and it also must see some weakening in the U.S. economy. Both of those factors support lower interest rates. But if the Fed is wrong, inflation could surge again. That danger makes TIPS attractive, even if real yields decline.

One thing to celebrate: All the TIPS you currently hold rose in value yesterday as yields plummeted. The net asset value of the TIP ETF surged from $105.30 just after 1 p.m. Wednesday to $107.51 this morning, a gain of 2.1% in less than 24 hours. Of course, we are all buy-and-hold investors, right? Ignore the noise.

What this means for T-bills

Yesterday, the Treasury auctioned a 17-week T-bill that got an investment rate of 5.432%, up from 5.421% the week before. That could end up being the highest yield we will see at that term for quite awhile, but so far T-bill yields have been holding up relatively well.

The 3-month T-bill is yielding 5.36% this morning, down just 10 basis points from two days earlier. That indicates investors don’t see rate cuts happening within the next three months. Seems logical.

The 12-month T-bill is yielding 4.86%, down 27 basis points from two days ago. In this case, investors seem to be pricing in a partial year of rate cuts. Also “somewhat” logical.

And the 2-year Treasury note? It is yielding 4.37% this morning, down 34 basis points this morning. That seems attractive to me. But remember, the yield curve should grow steeper as the short-term yields fall. And also keep in mind that the market was already pricing in future rate cuts, ahead of the Fed announcement.

Final thoughts

Is inflation really tamed? That will be the key question. If you listened to Jerome Powell’s news conference, you didn’t hear that definitive statement and in fact he repeatedly stated that inflation remains a concern. But I think the Fed feels satisfied that it can gradually get to a “neutral” short term interest rate of about 3% without causing inflation to surge.

The Fed has been wrong before. But in this case I think it was time to begin very gradually easing short-term interest rates, while maintaining the commitment to lowering the Fed’s swollen balance sheet.

What are your thoughts? Do the lower real yields sidetrack your investment plans? Are short-term Treasurys and money-market funds starting to look less attractive? Will you make a move to stretch out duration? Post your ideas below.

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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. Please stay on topic and avoid political tirades.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Cash alternatives, Federal Reserve, Inflation, Investing in TIPS, Treasury Bills|27 Comments

Posted on December 12, 2023 by Tipswatch

TIPS principal balances will fall 0.2% in January, based on non-seasonally adjusted inflation.

By David Enna, Tipswatch.com

Costs of shelter continued rising in November, offsetting declines in gas prices, resulting in seasonally-adjusted all-items inflation of 0.1% for the month, the Bureau of Labor Statistics reported today.

The all-items number came in above expectations of 0.0%, but annual inflation of 3.1% matched the consensus. Core inflation, which removes food and energy, rose 0.3% in November and 4.0% for the year, matching expectations.

On the positive side, annual U.S. inflation dropped a notch to 3.1% for the year ending in November, down from 3.2% in October. That is the lowest annual inflation rate since June.

The BLS noted that the shelter index increased 0.4% in November, after rising 0.3% in October, and was the largest factor (about 70%) in the increase in core inflation. Shelter costs are up 6.5% year-over-year. This news is likely to set off protests that CPI shelter is a lagging indicator and doesn’t reflect current conditions. But … it is what it is. More from the report:

• Food at home costs were up 0.1% for the month and 1.7% year-over year. U.S. consumers can appreciate these moderate numbers.
• Gasoline prices fell 6.0% in November and are now down 8.9% year-over-year.
• Costs of used cars and trucks increased 1.6% but are down 3.8% over the year.
• Costs of new vehicles fell 0.1%.
• Apparel costs fell 1.3%.
• The medical care index rose 0.6% in November.
• Costs of motor vehicle insurance rose 1.1% for the month and are up a shocking 19.2% year-over-year. (Be prepared when you get your next bill.)

Overall, I’d say this November inflation report came in about on target, with shelter costs again being the “suspicious” factor pushing inflation higher. Over the next 12 months, this trend is likely to reverse. The trend over the last year has been gradually-moderating inflation, but with core locking in at 4.0% with shelter as the major factor:

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 on TIPS and set future interest rates for I Bonds. For November, the BLS set the inflation index at 307.051, a decrease of 0.20% from the October number.

Remember that non-adjusted inflation tends to lag the official number toward the end of the year because of holiday-season discounting. So this deflationary number wasn’t a surprise, and you can expect to see another one for December before things turn around in January.

For TIPS. The November inflation index means that principal balances for all TIPS will decline 0.20% in January, after falling 0.04% in December. Here are the new January Inflation Indexes for all TIPS.

For I Bonds. The November inflation report is the second of a six-month string that will set the I Bond’s new variable rate, to be reset on May 1. So far, with four months to go, inflation has fallen 0.24% for this period. It’s too early to make any judgement about the new variable rate. We saw a similar pattern in November to December in 2022, but then non-seasonally adjusted inflation leaped higher in January 2023.

Here are the numbers so far:

What this means for future interest rates

Although all-items inflation came in slightly higher than expectations in November, I don’t believe this will have any real effect on the Federal Reserve’s thinking on interest rates. The Fed is highly likely to continue, for now, to hold short-term interest rates in the current range of 5.25% to 5.50%.

In fact, I’d guess these current inflation numbers won’t play a deciding role in the Fed’s interest-rate decisions. More likely, the Fed will be watching employment trends. If the job market begins to sour, the Fed will begin lowering the federal funds rate.

From this morning’s Wall Street Journal report:

The Fed is on track to hold rates steady at its meeting Tuesday and Wednesday, and the latest inflation data won’t change that path. The latest reading is probably a bit firmer than the Fed would like to see to be confident that inflation is moving back quickly to its 2% goal, but it is unlikely to alter the Fed’s near-term policy stance because inflation has improved markedly this year.

Both the stock and bond markets seem confident that the Fed will begin easing next year, possibly by spring. That isn’t the message the Fed intends to send, but it could be true. The path forward, in my opinion, is going to be “choppy.”

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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. Please stay on topic and avoid political tirades.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS|11 Comments

Posted on December 10, 2023 by Tipswatch

By David Enna, Tipswatch.com

You can’t watch CNBC for more than 10 minutes without hearing some analyst predict the Federal Reserve will begin cutting interest rates in March 2024 … or May … or certainly by June.

On the other hand, Fed officials have rigorously maintained that interest rates — while possibly not increasing again — will remain at current levels well into next year. This is what Fed Chair Jerome Powell said on December 1:

The FOMC is strongly committed to bringing inflation down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective.

It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.

Then we got Friday’s jobs report, with employers adding 199,000 jobs last month, considered a sign the U.S. economy is not faltering. The unemployment rate fell to 3.7%, down from October’s 3.9%. Average hourly earnings were up 4% year-over-year, exceeding the current inflation rate of 3.2%.

My conclusion: 1) The Fed doesn’t need to raise short-term interest rates, and 2) The Fed doesn’t need to cut short-term interest rates, at least until data begin showing a slowing U.S. economy.

But the bond and stock markets don’t seem to agree, thanks to a short-term focus. Bond yields have been falling for the last 45 days. The S&P 500 is up 5.25% over the last month. Highly speculative investments like Bitcoin have been surging higher. Here is a “moderate” view from Dryden Pence, chief investment officer at Pence Capital Management, predicting just a “couple” rate cuts next year:

In this video, CNBC’s Mike Santoli attempts to debunk the idea that the surge in higher-risk assets has been caused by predictions of a Fed pivot. “To me, the stock market right now is not at this level because we are assuming we will get 100 to 150 basis points of cuts next year,” he says. “It’s because … we have a little more of a sustainable moment in the expansion.”

Nice theory, but if this were true, you’d see mid- to longer-term bond yields sustaining at high levels. Instead, they have been declining sharply. Expectations of lower interest rates are driving this market.

Next week’s inflation report, coming Tuesday at 8:30 a.m. ET, will probably give another boost to market optimism. The forecast for November all-items inflation is 0.0%, which should inch the annual rate closer to 3.0%. Core inflation, however, is expected to remain steady at 4% year over year.

Real yields are declining

We’ve just had a “Goldilocks” period of above-inflation yields nearing 2.5% across all maturities, beginning Sept. 19 and lasting until early October. But that ended last week, with both the 10-year and 20-year real yields dipping below 2.0% for two days, before bouncing back on Friday in the wake of the positive jobs report.

Investors looking to build a solid ladder of TIPS investments, stretching well into their retirement years, had a nice opportunity to fill that ladder, or add to it. I think we will probably see lower yields heading into 2024, but nothing is certain.

Remember, real yields holding around 2% remain attractive. That yield is likely to cover any taxes owed, meaning your investment will at least match, or more likely easily exceed, future inflation, even after taxes. For perspective, here is a chart showing 5-, 10- and 30-year real yields since January 2020, just before the massive pandemic-triggered Federal Reserve easing beginning in March 2020:

This is a strange-looking chart because the yield curve is now close to perfectly flat. For the future, I expect a wider spread, and that will probably mean the shorter-term yields will fall and longer-terms will rise, or at least not fall as far.

This weekend, a Barron’s commentary backs me up:

The better question is where rates will settlein the coming decade. The probable answer: below today’s target range of 5.25%-5.50%, but higher than many economists and policy makers expected a year or two ago, and far higher than the near-zero rates of the past 15 years.

And then there is the fact that budget deficits are going to soar well into the future, forcing ever-higher Treasury borrowing. From Barron’s, a rather scary projection:

What this means for I Bonds

If real yields continue falling, the I Bond’s current fixed rate of 1.3% is going to look more and more attractive. Since Nov. 1, both the the 5-year and 10-year TIPS yields have averaged about 2.2%, which at this point would equate (possibly) to an I Bond fixed rate of about 1.3% to 1.4%. But if real yields continue falling, we very well could see a lower I Bond fixed rate at the May 1 reset. And that could be combined with a lower variable rate if inflation continues sliding lower.

The great thing about I Bonds is that the 1.3% fixed rate is available for purchases through the end of April 2024. Investors who purchase any time before then can lock in the 1.3% fixed rate for the life of the I Bond, plus a composite rate of 5.27% for a full six months.

Several readers have mentioned recently that they are considering over-paying 2023 estimated taxes to get $5,000 in paper I Bonds in lieu of next year’s federal tax refund. Not a bad idea, if you like this strategy.

At this point in time, for an experienced investor, TIPS yielding 2% above inflation remain more attractive than an I Bond with a fixed rate of 1.3%. But the gap is narrowing, and I Bonds have many advantages over TIPS: flexible maturity, better deflation protection and deferred federal taxes.

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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. Please stay on topic and avoid political tirades.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS, Retirement, Savings Bond|27 Comments

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