10-Year TIPS Reopening Gets Real Yield Of 0.174%, Lowest In 3 Years

Summary

• Real yields are near Treasury-estimate lows for 2019, but have popped slightly higher in recent weeks.
• Today's auction yield of 0.174% meant that investors had to pay a premium to get a 0.250% after-inflation coupon rate.
• The inflation breakeven rate came in at 1.60%, a three-year low. A number this low had to spur interest from big-money investors.

The U.S. Treasury's offering Thursday of $12 billion in a reopened 10-year Treasury Inflation-Protected Security resulted in a real yield to maturity of 0.174%, the lowest for this auction term in three years.

This is CUSIP 9128287D6, and the reopening created a 9-year, 10-month TIPS with a 0.250% coupon rate, which was set at the originating auction in July. Because today's auction yield came in lower than the coupon rate, investors had to pay a premium, about $101.04 for about $100.30 of value, after accrued inflation is added in.

A TIPS is a Treasury 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.

After-inflation yields have fallen dramatically in 2019, down from a high of 0.97% for a 10-year TIPS on January 28, according to U.S. Treasury estimates. This fall has made TIPS an unattractive investment for most small-scale investors, especially as inflation fears seem to be dwindling. But the inflation protection they provide versus similarly low-yielding nominal Treasurys is keeping demand strong among big-money investors like central banks and pension funds.

Here is the trend in the 10-year real yield since November 2018, showing the steep decline, even into negative real yields a few weeks ago:

Inflation breakeven rate

With a 10-year nominal Treasury trading today with a real yield of 1.77%, this reopened TIPS gets an inflation breakeven rate of 1.60%, also a three-year low for TIPS auctions of this term. This means CUSIP 9128287D6 will outperform a nominal Treasury if inflation averages higher than 1.6% over the next 9 years, 10 months. Although 1.6% seems ridiculously low, U.S. inflation over the last 10 years has averaged 1.7%, so it is not unreasonable.

Inflation breakevens have been climbing recently - but just slightly - as fears rise that unrest in the Mideast could disrupt supplies of crude oil. Gasoline prices have increased in the last week, which should be reflected in September inflation numbers.

A year ago, inflation expectations were running above 2.0%. But as fears of an impending U.S. recession grew, inflation expectations dwindled. Here is the trend since November 2018:

Reaction to the auction

In my preview to this auction, I made the case that this reopening auction should be avoided - the real yield was going to be too low to be attractive for small-scale investors. But it appears that demand was reasonably strong at this auction. The TIP ETF had been trading slightly higher all morning, and nudged higher after the auction's closed at 1 p.m. A higher ETF price means yields are falling, which in turn indicates positive demand.

This is reflected in Bloomberg's auction story just published:

Demand was stronger than at the last auction, judging by the bid/cover ratio, which compares the number of bids with the amount of securities sold. The ratio was 2.41, compared with 2.28 at the previous sale. It was the highest since 3.07 at the May auction.

Indirect bidders, a group that includes foreign central banks, bought 66.4 percent of the amount sold, compared with 64.3 percent in the prior auction.

TIPS at these yield levels remain attractive to big-money investors, who have few safe alternatives for large investments. But small-scale investors can still look at alternatives like U.S. Series I Savings Bonds (currently with a real yield of 0.50%), bank CDs, federal money market funds and FDIC-insured savings accounts to get a reasonable return for maximum safety, with better maturity terms.

Conclusion

I'd suggest steering away from five-year TIPS yielding lower than 0.40% and 10-year TIPS below 0.65%. It may be a while before we see yields that high again. If the U.S. economy slumps into recession, expect to see negative real yields all the way up to 20 years for TIPS.

Here's a history of all 9- to 10-year TIPS auctions since the last low point in September 2016:

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