Going Negative: 5-Year TIPS Auctions With A Real Yield Of -0.049%

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Includes: TIP
by: Tipswatch

Summary

Returns for this new TIPS will slightly lag inflation over the next five years.

The negative yield is an omen that the markets see a troubled economy ahead.

The inflation breakeven rate came in at 1.82%, a little higher than recent numbers.

The U.S. Treasury just announced that its auction of $16 billion in a new 5-year Treasury Inflation-Protected Security resulted in a real yield to maturity (after inflation) of -0.049%.

Yes, that is a negative number, and it means that returns for investors in CUSIP 912828X39 will slightly lag inflation over the next five years. Negative real returns for 5-year TIPS have been fairly common over the last six years, but this is still discouraging news for investors hoping to outpace inflation.

The Treasury set the coupon rate for this TIPS at 0.125%, the lowest it will go, and that means buyers at today's auction had to pay a premium for the 0.125% coupon rate. The adjusted price was about $101.00 for $100 of par value, including a small inflation adjustment at the April 28 issue date.

Although bond yields had been rising in the weeks after the November presidential election, they have taken a sharp fall in recent weeks. The Treasury's 5-year real yield estimate hit 0.22% on April 7 and has plummeted since.

Today's auction is evidence that big-money investors are willing to pay dearly for inflation protection. Smaller investors have other options, such as US Series I Savings Bonds and insured bank CDs, both of which could outperform this TIPS.

Here's a chart showing 5-year real yields since 2011, when the Federal Reserve began aggressively intervening in the Treasury markets. It shows how real yields had climbed back above zero after the election, only to fall back down in today's auction:

Inflation breakeven rate. With a 5-year nominal Treasury currently trading at 1.77%, this new TIPS gets an inflation breakeven rate of 1.82%, meaning it will outperform a nominal Treasury if inflation is higher than 1.82% over the next five years. That's a little higher than it has been trending recently, indicating stronger demand for TIPS.

U.S. inflation is currently running at 2.4%, so the market is pricing in lower inflation in the near term. That does not reflect a positive economic outlook, as reflected in this chart, showing that post-election inflation 'euphoria' seems to be dimming:

The Wall Street Journal carried an interesting analysis today on the meaning of inflation expectations. The headline was 'Bond Market Expecting Less Inflation':

Breakevens surged along with benchmark rates after the presidential elections as Mr. Trump promised to cut corporate taxes, spend on infrastructure, and deregulate industries, all of which were expected to spur growth and inflation. The buoyant outlook for inflation was a welcome sign for many, because rising consumer prices are thought to be one hallmark of a healthy economy.

But recently, doubts about when and how those policies will be enacted have weighed on bond market gauges of inflation. ... "The market kind of got a little ahead of itself in saying [Mr. Trump] will pass everything," said Eric Souza, a senior portfolio manager at SVB Asset Management.

The bond market is going to be interesting to watch in coming months. If yields continue to fall - signaling economic worries - that could mean trouble for the stock market, which remains at near-record highs. It could also mean the Federal Reserve will back off on interest rate increases in 2017.

This 5-year TIPS will be reopened in auctions in August and December.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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