New 30-Year TIPS Gets Record-Low Real Yield Of 0.261%

Summary

• The real yield of 0.261% was the lowest for any 29- to 30-year TIPS auction in history, and much lower than the previous record of 0.479%.
• The coupon rate also set a record low of 0.250%, much lower than the previous record of 0.625%.
• Long-term real yields are in a "weird" zone. Beware.

The U.S. Treasury's auction of a new 30-year Treasury Inflation-Protected Security went off Thursday with a sensational result: A record low real yield of just 0.261%, well below any 29- to to 30-year TIPS auction in history.

This was CUSIP 912810SM1, and the auction set its coupon rate at 0.250%, also a record low for any TIPS auction in history. No 30-year TIPS, dating back this security's birth in 1998, has ever had a coupon rate of less than 0.625%.

A TIPS is an 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.

In this case, CUSIP 912810SM1 will have a real yield to maturity of just 0.261%. No kidding, this is remarkable. Before today, the lowest auctioned real yield for any 29- to 30-year TIPS was 0.479%, set in the dark days of quantitative easing in October 2012. There have been 35 TIPS auctions of this term since 1998, and this one came in with the lowest yield ever, by a big margin.

Long real yields are ... weird

Over the last 10 years -- because of aggressive Federal Reserve intervention -- TIPS yields across a large spectrum have been much lower than they are today. But in February 2020, it is only the very long end of the yield curve that is severely depressed. I find this hard to understand, except that I have seen numerous commentaries recently extolling long-term TIPS as an investment. So, is high demand for long-term inflation protection driving yields lower? It could be. Two charts will provide evidence.

Let's take a a look at real yields for 5-, 10- and 30-year TIPS over the last 10 years. What I find very interesting is that the spread between the 30-year TIPS and the shorter maturities was very wide back in 2012, when the 30-year TIPS yield last reached its record low (until today):

Back on December 11, 2012 -- in the midst of Federal Reserve bond-buying -- the Treasury estimated real yields at these levels:

• 5-year TIPS, -1.45%
• 10-year TIPS, -0.86%
• 30-year TIPS 0.25% .... 170 basis points higher than a 5-year TIPS and 111 basis points higher than a 10-year TIPS.

Now, let's jump to February 11, 2020, just a few days ago:

• 5-year TIPS, -0.19%
• 10-year TIPS, -0.05%
• 30-year TIPS, 0.34%, 53 basis points higher than a 5-year TIPS and 39 basis points higher than a 10-year TIPS.

This demonstrates that long-term TIPS real yields are being bid down strongly, even in the absence of Federal Reserve intervention. This means there is strong global demand for long-term inflation protection.

In my opinion, though, this trend makes very long term TIPS overbought, very risky and very undesirable. In my opinion, there's a lot better chance that long-term yields will rebound higher, as short-term rates stay stable or even decline. I'd prefer investments in shorter-term TIPS.

The auction result

Investors at today's auction paid an adjusted price of about $99.68 for about $99.96 of value, after accrued inflation is figured in. The price ends up being a slight discount because this TIPS will have an inflation index of 0.99959 on the settlement date of February 28.

Inflation breakeven rate

With a nominal 30-year Treasury trading today at 1.97%, this new TIPS gets an inflation breakeven rate of 1.71%, a fairly attractive number. U.S. inflation is currently running at 2.5% and has averaged 1.8% over the last 10 years.

This relatively low inflation breakeven rate is a key factor in the appeal of a 30-year TIPS for big-money investors like foreign central banks, pension funds and hedge funds. This TIPS provides a predictable long-term return that is seen as favorable versus a 30-year nominal Treasury at 1.97%.

Reaction to the auction

The TIP ETF had been trading slightly higher all morning but took a strong move upward after the close of this auction at 1 p.m. EST. This is a good indication that the auction was met with positive demand.

But as I noted in my preview article, I was definitely not a fan of this new TIPS, and the results bore out my fears: Too much risk and too little return.

It is stunning to me that a small-scale investor can buy a zero-risk inflation-protected investment -- the U.S. Series I Savings Bond -- today with a fixed rate of 0.20%. That fixed rate is equivalent to the "real yield" of a 30-year TIPS, and is only 6 basis points lower.

I Bonds have significant advantages over 30-year TIPS, among them:

• You get a flexible maturity. An I Bond can be redeemed after one year for a three-month interest penalty or after five years with no penalty. Or, if held, it will continue paying inflation-adjusted interest for 30 years.
• You earn tax-deferred interest. No federal income tax is due until the I Bond is redeemed, a big advantage over a TIPS, where inflation accruals are taxed in the current year. This tax treatment makes the I Bond similar to a traditional IRA, but it is not subject to Required Minimum Distributions.
• You get rock-solid deflation protection. Even in times of severe deflation, an I Bond will never lose any of its accumulated value. This isn't true for a TIPS, where accrued principal falls in reaction to a deflationary month.
• You get a simpler investment. I-Bonds don't go up and down in "market" value. They simply pay inflation-adjusted interest, which accumulates and compounds over time. When you redeem them, you know exactly what you will receive. TIPS rise and fall with market swings until final maturity.

I am pounding the table for I Bonds. As for this new 30-year TIPS, I am just marking down its sad place in history. For the record, here is that history:

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.