Investor demand appeared to be lukewarm.
By David Enna, Tipswatch.com
The U.S. Treasury’s auction offering of $26 billion of a new 5-year Treasury Inflation-Protected Security — CUSIP 91282CPH8 — generated a real yield to maturity of 1.182%, down a whopping 52 basis points from a similar auction in April.
The result looked on target, but demand appeared a bit weak. At the auction’s close, the “when-issued” prediction was for a real yield of 1.17%. The result of 1.182% shows investors were not diving in. However, the bid-to-cover ratio was 2.51, a routine number for this term of TIPS.
Real yields, especially for shorter-maturity TIPS, have been declining as the Federal Reserve rolls out a wave of cuts to short-term interest rates. The next cut could come next week. Here is the trend in the 5-year real yield over the last two years, showing the substantial fall from the October 2023 highs:
The real yield managed to remain 8 basis points above the current fixed rate of the Series I Savings Bond, which has a fixed rate of 1.10% for purchases through the end of this month. For many investors, the I Bond is a more attractive investment at these rates, given the advantages of tax deferral, flexible maturity, and solid deflation protection.
Pricing
This is a new TIPS, which means the coupon rate was set at 1.125%, to the 1/8th percentage point below the real yield of 1.182%. That resulted in an unadjusted price of 99.726133, a slight discount. In addition, this TIPS will carry an inflation index of 1.00148 on the settlement date of Oct. 31. With that information, we can calculate the exact cost of a $10,000 par-value investment:
- Par value: $10,000
- Actual principal purchased: $10,000 x 1.00148 = $10,014.80
- Cost of investment: $10,014.80 x 0.99726133 = $9,987.37
- + accrued interest of $4.95 (to be returned at first coupon payment)
In summary, an investor paid $9,987.37 for $10,014.80 of principal at the settlement date of Oct. 31. From that point on, the investor will earn accruals to principal matching inflation plus an annual coupon rate of 1.125%, applied to inflation-adjusted principal.
Side note for nerds: This is the first time in the history of the 5-year TIPS, dating back to July 1997, that the coupon rate has been set at 1.125%.
Inflation breakeven rate
At the auction’s close, the nominal 5-year Treasury note was trading at 3.59%, setting up an inflation breakeven rate of 2.41% for this TIPS, a bit higher than recent results. This means CUSIP 91282CPH8 will out-perform the nominal 5-year if inflation averages more than 2.41% over the next five years.
That seems like a pretty even bet, but I’ll note that inflation over the last 5 years, ending in August, has averaged 4.5%. I’d prefer the TIPS until we see evidence that inflation is actually declining.
Here is the trend in the 5-year inflation breakeven rate over the last two years:
Thoughts
Although the real yield came in 1 basis point higher than the when-issued prediction, this looks like a fairly routine auction with a fair result. The U.S. Treasury’s 5-year real yield estimate closed Wednesday at 1.24%, but a yield that high never seemed likely, as I explained here. I’d say 1.182% was a good result for investors.
Here are auction results for 4- to 5-year TIPS over the last five years:
• Now is an ideal time to build a TIPS ladder
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• TIPS investor: Don’t over-think the threat of deflation
• Upcoming schedule of TIPS auctions
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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.
