10-Year TIPS Reopening Generates A Real Yield Of 0.567%

by: Tipswatch

The real yield of 0.567% was in line with where this TIPS was trading Thursday morning. No surprise, and the auction appears to have been met with strong demand.

Buyers had to pay a lofty premium, however, because the real yield fell well below the coupon rate of 0.875% generated at the originating auction in January.

The inflation breakeven rate came in at 1.73%, the lowest at auction for this term since September 2016.

The U.S. Treasury's reopening auction of a 10-year Treasury Inflation-Protected Security - CUSIP 9128285W6 - went off as expected Thursday, generating a real yield to maturity of 0.567%.

In the hours before the auction close at 1 p.m. EDT, this TIPS was trading on the secondary market with a yield of 0.56%, so the auction followed the market. That's an indication of solid demand for the $11 billion issue.

CUSIP 9128285W6 had its originating auction on January 17, when the results were much more attractive for investors: A real yield to maturity of 0.919% - about 35 basis points higher. That auction set the coupon rate for this TIPS at 0.875%, which holds through all auctions.

What did it cost?

TIPS are Treasury investments that pay a coupon rate lower than yields on nominal Treasurys of similar terms, but the principal balance of a TIPS rises (and possibly falls) in line with official inflation numbers each month. Investors in today's reopening will get a return of 0.567% above inflation over 9 years, 8 months.

Because the auctioned yield was well below the coupon rate, investors had to pay a premium price, about $103.54 for about $100.66 of value, after accrued inflation is added in (This TIPS will have an inflation index of 1.00655 on the settlement date of May 31).

In my preview article on this auction, I noted that the premium price in effect will wipe out a year of interest and accrued inflation. For that reason, I wasn't a huge fan of this reopening.

But a return of 0.567% could be viewed as "acceptable" when measured against 10-year real yields over the last five years, as shown in this chart:

10-year real yields

(Source: Federal Reserve of St. Louis)

Inflation breakeven rate

With a 10-year nominal Treasury currently trading with a yield of 2.30%, investors in this TIPS get an inflation breakeven rate of 1.73%, the lowest at auction for this term since September 2016. The breakeven rate means this TIPS will outperform a nominal Treasury if inflation averages more than 1.73% over the next 9 years, 8 months.

Although 1.73% is probably "fair value" given current trends of very low inflation, I'd say it's attractive. It should have been a factor in generating decent demand for this TIPS, especially by big-money investors like foreign central banks and pension funds.

Here is the trend of the 10-year inflation breakeven rate over the last five years, showing the deep drop in inflation expectations in 2016 and the later rise after the presidential election of 2016:

10-year inflation breakeven rate

(Source: Federal Reserve of St. Louis)

Reaction to the auction

TIP ETF The TIP ETF - which holds a full range of maturities - was trading slightly higher all morning Thursday, and got a bit of a boost immediately after the auction's close at 1 p.m. EDT. This generally indicates a positive market reaction to the auction. It also indicates that TIPS yields are falling slightly today, across all maturities - another indication of demand.

The Reuters report on the auction backs up this view:

The ratio of bids to the amount of 10-year TIPS offered was 3.07, the highest level since April 2010. This measure of overall auction demand was 2.42 at the prior 10-year TIPS sale, worth $13 billion, conducted in January, Treasury data showed.

Although I wasn't a fan of this reopening auction from a small-scale investor's point of view, the fact that it generated a real yield well above 0.50% is encouraging. The auction result of 0.567% was only slightly lower than the March reopening, which ended at 0.578%. This indicates that for the time being at least, real yields have stabilized.

This auction closes the history of CUSIP 9128285W6. The Treasury will auction a new 10-year TIPS in July and reopen that one in September and November.

CUSIP 9128285W6 (Source: TIPSWatch.com)

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 be purchased through the Treasury or other providers without fees, commissions or carrying charges.