New 5-Year TIPS Gets An After-Inflation Yield Of 0.515%

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Includes: TIP
by: Tipswatch
Summary

Last April, a similar auction generated a real yield of 0.631% and a coupon rate of 0.625%, both better results than today's.

The inflation breakeven rate came in at 1.85%, a fair number in today's time of muted inflation.

A mild market reaction indicates this was a solid auction, and investors can be pleased by snagging a 0.50% coupon rate.

Today's auction of $17 billion in new five-year Treasury Inflation-Protected Security, CUSIP 9128286N5, generated a real yield of 0.515%, the lowest rate for this term in more than a year.

That set the coupon rate on this new TIPS at 0.50%, a solid result for investors because 5-year TIPS real yields had been lingering near 0.50% for a few weeks. A dip below 0.500% in the auctioned real yield would have set the coupon rate at 0.375%.

The coupon rate of a TIPS confuses some investors because it is lower than that of a comparable nominal Treasury. However, with a TIPS, principal balances are adjusted higher or lower each month to reflect U.S. inflation. So the coupon rate is a payment on top of inflation. The "real yield to maturity" is determined by the auction.

Today's originating auction closed at 11:30 a.m. EDT instead of 1 p.m. because of the upcoming Easter holiday. Investors ended up paying an adjusted price of about $100.18 for about $100.21 of value, after accrued inflation is added in. This TIPS will carry an inflation index of 1.00211 on the settlement date of April 30.

So although the adjusted price was above $100, investors did get this TIPS at a slight discount, as is always true in an originating auction, where the coupon rate is set below the real yield.

Real and nominal yields for U.S. Treasurys have been declining in 2019 after solid increases in 2018. Last year's April auction of a 5-year TIPS generated a real yield of 0.631%. The yield on that same TIPS soared to 1.129% in a December reopening. Since then, real yields have been moving downward.

Here's a snapshot of 5-year real yields over the last year, showing the sharp decline since January. Today's auction result was actually close to a one-year low in yield:

5-year real yields Inflation breakeven rate

With a 5-year nominal Treasury trading at 2.37% today, this new TIPS gets an inflation breakeven rate of 1.85%, meaning it will outperform a nominal Treasury if inflation averages higher than 1.85% over the next five years. I consider this a "fair value," reflecting current trends in inflation. A 5-year TIPS isn't cheap nor expensive versus a nominal Treasury.

As real and nominal yields have declined this year (reflecting a dovish stance on interest rates by the Federal Reserve), inflation expectations have been rising, which also indicates stronger investor demand for TIPS. Here is the one-year trend in the 5-year inflation breakeven rate, showing the sharp increase since January:

5-year inflation breakeven rate Reaction to the auction

TIP ETF The TIP ETF, which holds the full range of maturities, nudged higher after the auction's close at 11:30 a.m. EDT, which indicates a positive (or at least neutral) reaction.

Overall, this looks like a solid auction for investors, who were able to snag the 0.50% coupon rate versus 0.375%. Although the real yield is the more important factor, a higher coupon rate is a plus because it generates more immediate cash flow.

This 5-year TIPS will be reopened in April. A new 5-year TIPS will be auctioned in October and reopened in December.

Here are auction results for the 4- to 5-year term over the last five years, showing that today's real yield of 0.515% was "relatively" attractive when viewed against the recent past:

5-year TIPS auctions

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.

Additional disclosure: 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.