By David Enna, Tipswatch.com
The Treasury on Thursday will offer $21 billion in a new 10-year Treasury Inflation-Protected Security, CUSIP 91282CRE3. There’s a good chance this auction will generate the highest real yield to maturity for this term in nearly 18 years.
The real yield and coupon rate will be determined by the auction results. But U.S. Treasury estimates placed the likely real yield at 2.31% at Friday’s market close. The most recent TIPS of this term, issued in January, closed Friday at 2.29%.
Things will change by Thursday, but it’s clear that CUSIP 91282CRE3 will get an attractive result, historically speaking. It looks likely to place 2nd on the chart at right, under the remarkable 2.85% real yield recorded on Oct. 8, 2008, in the midst of a massive market sell-off caused by the 2008 financial crisis.
Definition: The “real yield to maturity” of a TIPS is its yield above future U.S. inflation, over the term of the TIPS. So a real yield of 2.31% means an investment in this TIPS would provide a return that exceeds official U.S. inflation by 2.31% for 10 years.
As I noted, market conditions are likely to change by the Thursday auction. The 10-year real yield dipped 4 basis points on Friday, possibly because of a flight to safety in reaction to stock market jitters. But a real yield around 2.30% seems likely. You can track the current Treasury estimate on this page after each market close.
Here is the trend in the 10-year real yield going back to the financial crisis of 2008, showing that today’s real yields are hitting multi-year highs, minus any overt financial crisis:
Pricing
Because this is a new TIPS, the coupon rate will be set at the one-eighth percentage point below the auctioned real yield. So if the real yield turns out to be 2.31%, the Treasury will set the coupon rate at 2.25%. This would be the highest coupon rate for any new 10-year TIPS since July 2007 at 2.625%.
Because the coupon rate will be lower than the real yield, the unadjusted price is going to slightly discounted. In addition, this TIPS will carry an inflation index of 1.00325 on the settlement date of July 31. In the end, the investment cost should be slightly less than par value.
Inflation breakeven rate
With the nominal 10-year Treasury note closing Friday at 4.55%, this TIPS currently has an implied inflation breakeven rate of about 2.24%, which seems entirely reasonable. That’s 26 basis points lower than the 2.50% high hit on May 4, when Brent crude prices had soared to $115. Crude prices are now down to about $88, but there is a lot of inflationary risk, possibly long-term risk.
Fixed-income investors: Do you think inflation will average more than 2.24% over the next 10 years. If “yes,” buy the TIPS. If “no,” buy the nominal Treasury.
Here is the trend in the 10-year inflation breakeven rate over the last 18 years:
In this chart, note the deep declines in inflation expectations in the two recessionary periods. It’s interesting that the breakeven rate doesn’t plunge until the recession is under way. Also, note that the breakeven rate is a lousy predictor of future inflation.
Also … I’d say the early months of a recession are a good time for traders to buy TIPS to try to catch the initial spike in yields as financial assets sell off, and then trade out when yields plummet. This isn’t my strategy, of course.
Thoughts
A chance to get the highest real yield at auction in nearly 18 years is appealing, and tempting. But I won’t be a buyer Thursday. I filled the 2036 rung of my TIPS ladder with a purchase at the January auction, getting a real yield of 1.940% — good but probably well below Thursday’s result.
There are economic forces, such as lower international purchasing and soaring U.S. debt loads, that could cause real yields to continue to climb. But a real yield in the 2.3% range over 10 years remains very attractive, especially if held to maturity. This is a new TIPS, so there is no secondary market alternative (yet) that will mature in in the second half of 2036.
If you are looking to invest, keep an eye on the Treasury’s real yield estimates, posted at the end of each market day. That’s a good indicator.
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:
• 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
—————————
Donate? This site is free and I hope to keep it that way. Some readers have suggested having a way to contribute. I welcome donations, any amount. And FYI, ads on this site pay for about one visit to Costco.
—————————
Follow Tipswatch on X for updates on daily Treasury auctions and real yield trends (when I am not traveling).
Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear. Please stay on topic and avoid political tirades. NOTE: Comment threads can only be three responses deep. If you see that you cannot respond, create a new comment and reference the topic.
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.
