The U.S. Treasury announced Thursday that it will auction a new 30-year Treasury Inflation-Protected Security on February 15. This is CUSIP 912810SB5, and the coupon rate and real yield to maturity will be determined by the auction.
Although 30-year real yields (meaning after inflation) have been rising recently, I don't think this will be an attractive offering. A 30-year TIPS is a highly volatile investment, has cash-flow problems if held in a taxable account, and has a too-long maturity for many buy-and-hold-to-maturity investors. For those reasons, the after-inflation yield had better be outstanding to warrant an investment. It isn't.
Checking the yield trend. The best source of data for a new offering like this one is the Treasury's Real Yields Curve page, which estimates after-inflation yields each day. At Thursday's close, the 30-year estimate was 0.99%, up 22 basis points since January 1. That current yield is in line with the last three auctions of this 29- to 30-year term, and it's very possible that yield will climb above 1.00% by next Thursday's auction.
So, is 0.99% above inflation attractive enough? I'd say no, not when a 5-year TIPS (which will be auctioned in April) is yielding 0.68% and a 10-year (to be reopened in March) is yielding 0.76%. Those shorter-term yields have been climbing faster than the 30-year. They are a lot more attractive, with a lot less volatility. Here's a look at the 30-year real yield versus the 10-year over the last eight years:
Right now, the yield spread between the maturities is down to 23 basis points, the lowest since 30-year TIPS returned to the auction market in February 2010. When the spread is that low, a 10-year TIPS is much more attractive, even for an investor with a 30-year timeline
Checking the inflation breakeven rate. The current yield estimate for a full-term nominal 30-year Treasury is 3.14%, meaning this new TIPS will have an inflation breakeven rate of about 2.15%, which is reasonable. It would outperform a nominal Treasury if average inflation surpasses 2.15% over the next 30 years.
But inflation expectations have been rising sharply, up from 1.81% on June 15, 2017. When inflation expectations rise, nominal yields become relatively more attractive, and TIPS become more "expensive." The nominal 30-year yield is up 33 basis points so far this year compared to 22 basis points for the 30-year TIPS. Here's the trend since 2010:
At this point, I'd say that a breakeven rate of 2.15% means this new TIPS is still more attractive than a 30-year nominal Treasury yielding 3.14%. But any investor in next Thursday's auction should keep an eye on this trend.
And by the way, if you think a 3.14% nominal yield is attractive on a 30-year investment, take a look at Series EE U.S. Savings Bonds, which will double in value if held 20 years. That's a return of 3.5% in 20 years.
Understanding volatility. A 30-year TIPS is among the most volatile of all Treasury investments. Even a small swing in market yield can cause a sharp rise or fall in its market value. This might not matter to a buy-and-hold investor, but that 30-term makes a buy-and-hold investment questionable.
Here's what happens when a new 30-year TIPS enters a rising interest rate environment:
Three years ago, CUSIP 912810RL4 auctioned with a real yield of 0.842%, which set the coupon rate at 0.750%. Eight months later, its market value had fallen about 7.5%, based on just a 36-basis-point swing in yield. It is trading on the market today with a cost of about $94.33 for $100 of par value.
The cash flow problem. Buyers at Thursday's auction should cheer if the real yield climbs above 1.00%, which would set the coupon rate at 1.00% instead of one notch lower, 0.875%. The coupon rate is the cash flow a TIPS will generate over a 30-year term. All the inflation-adjusted return is added into principal and won't be realized until the TIPS matures or is sold.
By my calculations, a coupon rate of 1% would just barely make a 30-year TIPS cash-flow positive, if inflation averages 2.1% over 30 years. Remember, the IRS views the inflation adjustment to principal a taxable event for the current year. Here's the math:
- $10,000 in this TIPS will generate $100 a year in immediate cash flow, rising with inflation.
- If inflation averages 2.1% a year, the TIPS principal will increase $210 a year, rising with inflation.
- If you are in a 32% tax bracket, your tax bill in year one will be $99.20 on the $310 total you received.
- You are 80 cents cash flow positive, rising with inflation, every year for 30 years.
If inflation averages higher than 2.1%, your investment will be cash flow negative for 30 years. Don't buy this TIPS in a taxable account.
Yes or no on this 30-year TIPS? The yield/risk ratio doesn't justify an investment for anyone who can't absolutely, positively hold this TIPS to maturity. And even then, the investment must be in a tax-deferred account. Otherwise, reserve the cash for upcoming 5- and 10-year TIPS auctions, which offer more attractive yields versus risk.
Here's a history of all 29- to 30-year TIPS auctions:
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