10-Year TIPS Reopening Gets A Gorgeous Result

Mar. 20, 2020 11:01 AM ETTIP, VTIP, SCHP, STIP, SPIP, LTPZ, TIPZ, STPZ, TDTF, TIPX, TDTT, PBTP19 Comments14 Likes
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Summary

  • This was an investor-friendly auction: The real yield of 0.68% was much higher than looked likely a week ago.
  • The inflation breakeven rate of 0.43% is "out-of-normal" low and seems to be pricing in a dire economic future.
  • Treasury markets are in flux, with asset pricing and yields difficult to predict.

One of the strangest weeks in the history of Treasury Inflation-Protected Securities ended Thursday with a beautiful result for investors: The Treasury's reopening auction of a 10-year TIPS got a real yield to maturity of 0.680%, much higher than looked likely just days ago.

This is CUSIP 912828Z37, and the Treasury was offering $12 billion in this reopening, which created a nine-year, 10-month TIPS. CUSIP 912828Z37 was created in an originating auction on Jan. 23, when it got a real yield to maturity of 0.036%, much lower than today's result. This issue carries a coupon rate of 0.125%, the lowest the Treasury will go for a TIPS.

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.

Because Thursday's auction got a real yield much higher than the coupon rate of 0.125%, investors got it at a nice discount: about $94.99 for about $100.26 of value, after accrued inflation is added in. This TIPS will carry an inflation index of 1.00255 on the settlement date of March 31.

CUSIP 912828Z37 trades on the secondary market, so investors could get a decent idea of its likely price and yield. Less than a week ago, it was trading with a real yield to maturity of 0.04%, barley above zero. But in the last week, the TIPS market has been battered by a plunge in oil prices (raising deflation fears) and the global spread of COVID-19 (raising depression fears).

Even Thursday morning, at around 10:30 am EDT, this TIPS was trading on the secondary market with a real yield of 0.44%. The auction result, less than three hours later, came in 24 basis points higher.

This chart shows how 10-year real yields have increased dramatically since dipping well below zero in early March, a trend that went even higher today (not reflected in the data):

10 year real yields in 2020Less than a week ago, in my preview article for this auction, I speculated that this TIPS would be desirable if the yield could hold above zero. No problem! I have been amazed by turmoil in the Treasury markets in the last two weeks, as the stock market plummets and fears of recession grow. And this has been the result, according to Treasury estimates of 10-year real yields:

  • Thursday, March 12 = -0.04%
  • Friday, March 13 = 0.04%
  • Monday, March 16 = 0.00%
  • Tuesday, March 17 = 0.39%
  • Wednesday, March 18 = 0.55%
  • Today's auction = 0.68%

I suspect there isn't good "liquidity" right now in the Treasury markets, meaning its hard to match buyers and sellers at a steady price. Also, some big investors seem to be dumping assets to move to cash, specifically U.S. dollars. And many investors are pricing in a long spell of deflation in coming months, forcing real yields higher to compensate.

Inflation breakeven rate

With a 10-year nominal Treasury trading at 1 p.m. with a yield of 1.11%, this TIPS gets an inflation breakeven rate of 0.43%, an amazingly low number. It means this TIPS will outperform a nominal Treasury if inflation averages more than 0.43% over the next nine years, 10 months. In my opinion, this looks like an irrational market reaction, caused by... what? Panic? Rush to cash? Fear of a looming depression?

My prediction: Over the next 10 years, inflation will average more than 0.43% a year, and this TIPS will be an excellent investment versus a nominal Treasury.

Here is the trend for the 10-year inflation breakeven rate in 2020. Note that today's deep fall to 0.43% is not reflected in the data:

10-year inflation breakevenIf this auction had fallen into a more "normal" range (defined as normal in the year 2020 USA) the inflation breakeven rate would have been around 1.5%, at the worst, and the TIPS' real yield would have been about -0.40%, versus the nominal Treasury yield of 1.11%.

Instead, investors got a 100-basis-point bonus. And that makes this a gorgeous result for anyone who participated.

Reaction to the auction

TIP ETF 1-day tradeThe TIP ETF - which has been hit by volatile trading over the last week - had been trading slightly higher all morning, indicating slightly lower yields. After the auction close at 1 p.m. EDT, it moved slightly higher, only to trend back down. This looks like a fairly mundane reaction.

Remember, at one point Thursday morning, this same TIPS was trading on the secondary market with a real yield of 0.44%, and the auction result was 0.68%. However, it closed last night with a yield of 0.61%, so today's result wasn't a gigantic surprise.

An inflation breakeven rate of 0.43%, however, send a fairly dire warning to the financial markets: Trouble ahead.

From a Bloomberg report today about the rush to cash in the form of the U.S. dollar:

“Everything is getting sold,” said Chris Rands, portfolio manager at Nikko Asset Management Ltd. “We’re doing the absolute bare minimum because offering to sell anything in these markets is just crazy - we’re trying our best to hang on and see where it all shakes out. I don’t see this dollar stampede going away.”

Conclusion

This was a rare TIPS auction where everything went the investor's way. I am expecting that TIPS real yields in coming weeks will begin to return to more "normal" levels, meaning at current nominal rates these 10-year real yields will drop below zero. TIPS mutual funds and ETFs are also worth a look at this point, with the price of the TIP ETF closing yesterday at $108.81, down from $122.56 on March 6.

The TIP ETF rose today to $110.92, up 1.9% in a single day. The Treasury market is being roiled, with volatile swings pushing values outside the norm. So this presents some investment opportunities, with limited risk, when gyrations force prices down.

Today's TIPS auction was a good example: An unexpectedly high real yield, sort of a "gift" to the watchful investor.

Coming on April 23 is a an auction of a new five-year TIPS, which if auctioned today would have generated a real yield of about 0.52%, definitely worth a look. Will this trend continue? We'll need to wait a month to see.

This article was written by

Tipswatch profile picture
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Note: Because of dramatic changes in SeekingAlpha's payment structure in November 2020, I am no longer writing for this site. More details. I will continue to post updates at my site, TipsWatch.com.-----David Enna is a long-time journalist based in Charlotte, N.C. A past recipient of two Society of American Business Editors and Writers awards, he has written on real estate and home finance, and was a founding editor of The Charlotte Observer's website. The Tipswatch blog, which launched in April 2011, explores ideas, benefits and cautions about U.S. Series I Bonds and Treasury Inflation-Protected Securities, which David believes are an under-appreciated and under-used investments. David has been investing in TIPS and I Bonds since 1998.
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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.

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