Real Yield On 10-Year TIPS Reopening Drops To 0.149%, Lowest In 3 Years

Summary

• The Treasury market isn't attractive right now for small scale investors.
• A real yield of 0.149% was the lowest for any 9- to 10-year TIPS since an auction in September 2016 generated a real yield of 0.052%.
• The inflation break-even rate came in at 1.62%, low by historical standards but not out of line with recent results.

The U.S. Treasury's auction of $12 billion in a reopened 10-year TIPS generated a real yield to maturity of 0.149%, the lowest for any auction of this maturity since September 2016.

This is CUSIP 9128287D6, a 10-year TIPS that had an originating auction on July 18, 2019. It carries a coupon rate of 0.250%, based on the real yield to maturity at that July 18 auction, which came in at 0.282%.

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.

At a reopening auction, the auctioned real yield to maturity is compared to the coupon rate to determine the price investors will pay... above or below par.

Because the real yield of Thursday's auction came in under the coupon rate of 0.250%, the result is that investors paid a premium over par value for the resulting 9-year, 8-month TIPS. The price was about $101.34 for about $100.37 of par value, after accrued inflation is added in. This TIPS will have an inflation index of 1.00372 on the settlement date of November 29.

It's remarkable to see the 10-year real yield dip as low as 0.149%, just a year after a similar auction generated a real yield of 1.109%. That's a drop of 96 basis points, spurred by Federal Reserve actions to lower short-term interest rates, plus investors' increasingly negative view of the U.S. economy.

Here is the trend in the 10-year real yield over the last 10 years, showing the deep dive after the Federal Reserve began an aggressive bond-buying program in mid 2011:

So today's real yield of 0.149% isn't an outlier compared with results over the last 10 years, but it does reflect a flight to safety as global economies weaken. Could this downward trend continue? Definitely, if the U.S. economy shows any signs of weakness.

But my strong feeling is that the U.S. Treasury market - both nominals and TIPS - isn't attractive right now for small scale investors. Yields are too low versus historical standards. Look elsewhere to invest for safety... Possibly U.S. Series I Savings Bonds or insured bank CDs.

Inflation break-even rate

With a 10-year nominal Treasury trading today with a yield of 1.77%, this reopened TIPS gets an inflation break-even rate of 1.62%, meaning it will outperform a Treasury if inflation averages 1.63% or higher over the next 9 years, 8 months. That number is low by historical standards but also isn't an outlier compared to results of recent TIPS auctions. A reopening of this same TIPS on September 19 generated an inflation break-even rate slightly lower, at 1.60%.

Even with U.S. inflation currently running at 1.8%, investors in nominal Treasurys are gambling that inflation will dip even lower over the next 10 years. If they believed inflation will be higher, the inflation break-even rate would be higher. Here is the trend in the 10-year inflation break-even rate over the last 10 years. Note how often this rate rose above 2.0%, even as recently as 2018:

The lower the inflation break-even rate goes, the more attractive a TIPS is versus a nominal Treasury. So at this point, while low real yields make TIPS an unattractive investment, they are certainly more attractive than a nominal Treasury of the same term.

Here are results from all the 9- to 10-year TIPS auctions since 2016, showing that the inflation break-even rate has been steadily drifting lower, reflecting the belief by many investors that inflation may not be dead, but it is certainly under control.

Under these circumstances, even a TIPS with a lousy real yield of 0.149% could be viewed as a decent value for big money investors.

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