Are we entering an era of lower real returns?
By David Enna, Tipswatch.com
The U.S. Treasury on Thursday will auction $19 billion in a reopened 10-year TIPS, CUSIP 91282CNS6. This will be a notable auction because the real yield to maturity is likely to fall to a two-year low, a level not seen at auction since July 2023.
CUSIP 91282CNS6 had its originating auction two months ago, on July 24, when its real yield to maturity came in at an attractive 1.985%. The coupon rate was set at 1.875%. But in the last two months, real yields have dipped fairly dramatically.
This TIPS trades on the secondary market, where it closed Friday with a real yield of 1.69% and a price of 101.64. The price is at a premium because the real yield has dropped below the coupon rate. You can track the current yield and price on Bloomberg’s Current Yields page.
Definition: The “real yield to maturity” of a TIPS is its yield above official future U.S. inflation, over the term of the TIPS. So a real yield of 1.69% means an investment in this TIPS would provide a return that exceeds U.S. inflation by 1.69% for 9 years, 10 months.
One day before Thursday’s auction closes at 1 p.m. ET, the Federal Reserve is highly likely to cut short-term interest rates by 25 basis points and signal that future rate-cutting is coming in an effort to support a sagging job market. The 25-basis-point cut is already priced into CUSIP 91282CNS6’s yield, but comments by Fed chair Jerome Powell Wednesday afternoon could set the bond market roiling. In other words: Expect volatility in the hours leading up to the auction.
Here is the trend in the 10-year real yield over the last 15 years:
The chart shows that the current real yield of 1.69% remains historically attractive, but has fallen well off the October 2023 high of about 2.55%.
Pricing
At Friday’s close, CUSIP 91282CNS6 was trading with a real yield of 1.69% and a price of 101.64. In addition, on the auction’s settlement date of September 30, this TIPS will have have an inflation index ratio of 1.00602. With that information, we can estimate the cost of a $10,000 par value investment at the auction:
- Par value: $10,000
- Accrued principal on settlement date: $10,000 x 1.00602 = $10,060.20
- Cost of investment: $10,060.20 x 1.0164 = $10,255.19
- + accrued interest of about $39.47
Again, this is an estimate based on Friday’s closing price. In this scenario, the investor would pay $10,255.19 for $10,060.20 of principal on the settlement date, and from that point on would earn inflation accruals plus a coupon rate of 1.875% until maturity. Things will change before Thursday, but this gives you an idea.
Inflation breakeven rate
The 10-year Treasury note closed Friday with a nominal yield of 4.06%, giving this TIPS a current inflation breakeven rate of 2.37% –in line with recent auctions of this term. That means CUSIP 91282CNS6 will out-perform a nominal 10-year if inflation averages more than 2.37% over the next 9 years, 10 months. Inflation over the last 10 years, ending in August, has averaged 3.1%.
Here is the trend in the 10-year inflation breakeven rate over the last 15 years, showing the fairly stable pattern since the closing months of 2022:
Thoughts
Real yields for TIPS of short- to medium-terms have been falling over the last several months, in anticipation of future rate-cutting by the Federal Reserve. This could indicate a trend that will continue well into 2026, especially if the U.S. economy dips into recession. Or … it could be an overshoot to the low side. The Federal Reserve on Wednesday may help clarify this issue (but probably won’t).
I will not be a buyer at this auction because I have my sights on the January 2026 auction of a new 10-year TIPS, to add 2036 to my TIPS investment ladder. Will real yields be quite a bit lower by then? Maybe. I’ll wait it out.
Keep in mind that despite the boost from tariff revenues, the federal deficit is highly likely to continue increasing for years into the future. That will mean more borrowing and — potentially — higher yields. Note that the 20-year TIPS still has a real yield of 2.17% and the 30-year, 2.43%.
Relevant side note: This TIPS auction size of $19 billion will be the highest in history for any 10-year TIPS reopening. This is a 12% increase over last year’s September auction at $17 billion.
Also, note that if you have a brokerage account, there is no compelling reason to buy this TIPS at auction versus on the secondary market, unless you plan to make a small purchase at TreasuryDirect.
The advantage of buying at auction, especially through TreasuryDirect, is that even small-lot purchases will get the auction’s high yield. The advantage of the secondary market is that you can see exactly the price and real yield you will be receiving. The negative is that you may face a small bid-ask spread. Most of the time, it doesn’t make a huge difference, but if you see a real yield you like, know that you can probably get it on the secondary market without dealing with the auction’s uncertainty.
This TIPS auction closes Thursday at 1 p.m. ET. Non-competitive bids at TreasuryDirect must be placed by noon Thursday. If you are putting an order in through a brokerage, make sure to place your order Wednesday or very early Thursday, because brokers cut off auction orders before the noon deadline.
I will be posting the auction results soon after the close on Thursday. Here is a history of auction results for this term over the last 5 years:
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
