By David Enna, Tipswatch.com
The Treasury’s reopening auction of a 5-year Treasury Inflation-Protected Security — CUSIP 91282CQP9 — generated a real yield to maturity of 1.955%, a good result for investors.
Real and nominal Treasury yields moved higher late Wednesday after the Federal Reserve held short-term interest rates in a range of 3.50% to 3.75%. But dot-plot projections from Fed members made it clear that rate increases could be coming later in the year if U.S. inflation does not begin cooling.
I watched Kevin Warsh’s news conference and I’d say he tried valiantly to make things look calm at the Fed, but there is a lot of apparent dissent. Other than that, I can’t say I know much more, since I am on holiday in southern France.
Before the Fed meeting, the 5-year real yield had been hovering in an already-elevated range of 1.78% to 1.82%. So today’s auctioned real yield of 1.955% was a sharp move higher. Plus, the auction drew solid demand. The “when-issued” prediction was 1.96% and the bid-to-cover ratio was 2.61, also a good number.
The statistics indicate we are entering a period of higher real yields. Maybe short term? Maybe not?
Consider this: Two months ago, this same TIPS generated a real yield to maturity of 1.367% at its originating auction on April 23. Today’s result was 57 basis points higher. That’s a big move.
Here is the trend in the 5-year real yield over the last two years, showing that today’s move higher is still off highs of late 2023, early 2024, and early 2025:
Pricing
Because the real yield of 1.955% was well above the coupon rate of 1.25%, this TIPS auctioned at a strong discount, with an unadjusted price of 96.787926. It also will carry an inflation index of 1.02135 on the settlement date of June 30. Here is the resulting cost of a $10,000 par value investment at this auction:
- Par value: $10,ooo.
- Adjusted principal on settlement date: $10,000 x 1.02135 =$10,213.50.
- Cost of investment: $10,213.50 x 0.96787926 = $9,885.43
- + accrued interest of $26.51.
In summary, an investor purchasing $10,000 par value at this auction paid $9,885.43 for $10,213.50 of principal on the June 30 settlement date. From then on, the investor will earn accruals matching official U.S. inflation, plus 1.25% annual interest on adjusted principal. The accrued interest will be returned at the next coupon payment on Oct. 15, 2026.
Inflation breakeven rate
The 5-year Treasury note was trading with a nominal yield of 4.20% at the auction’s close, giving this TIPS an inflation breakeven rate of 2.25%, which seems low to me under current economic conditions. The originating auction in April got an inflation-breakeven rate of 2.58%. Inflation over the last 5 years, ending in May, has averaged 4.5%.
This week’s peace announcement, along with the potential for lower energy prices, is probably a big factor in easing inflation expectations.
Here is the trend in the 5-year inflation breakeven rate over the last two years, showing the strong move higher after the outbreak of war in the Middle East and the more recent move lower.
Thoughts
I spent the entire day in Aix-en-Provence, one of my favorite places on Earth, and really didn’t follow Treasury trends closely. I am assuming the Fed’s mixed messages created fears of rising short-term interest rates, and the 5-year TIPS maturity is the most sensitive, at auction, to those trends.
If you invested in this auction, or have other feedback or ideas, please start the discussion in the comments section. Without going into political rants, what did you think of Kevin Warsh’s performance? What should the Fed be doing? I will try to watch! Meanwhile, here is a history of 4- to 5-year TIPS auctions over the last two 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.
