By David Enna, Tipswatch.com
The Treasury’s auction today of a new 10-year Treasury Inflation-Protected Security, CUSIP 91282CRE3, generated a real yield to maturity of 2.438%, the highest at auction for this term since October 2008.
Investor demand appeared to be weak. The bid-to-cover ratio was a lukewarm 2.30 and the “when-issued” prediction used by bond traders was for a real yield of 2.41%. The higher auction result indicates weak demand.
But for investors … this was an excellent auction. Earlier Thursday, a similar TIPS was trading on the secondary market with a real yield of 2.38%. That rose to 2.41% as tensions continued building in the Mideast. The auction result of 2.438% indicates tensions continue, as indicated by sharp declines in both stocks and bonds today.
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 2.438% means an investment in this TIPS would provide a return that exceeds official U.S. inflation by 2.438% for 10 years.
Global tensions, along with massive debt-issuance needs by the U.S. government and AI-building corporations, have been pushing both nominal and real yields higher in recent weeks. Both the 20-year and 30-year TIPS are inching toward 3% real yields today.
CUSIP 91282CRE3 gets a coupon rate of 2.375%, the highest for this term since a 10-year auction on July 12, 2007, with a coupon rate of 2.625%.
Here is the year-to-date trend in the 10-year real yield. Notice the sharp upward path (and also that data for this chart ended on Tuesday, below today’s auction result):
Pricing
Because the coupon rate (2.375%) was set below the auctioned real yield (2.438%), this TIPS sold at a discounted unadjusted price of 99.444895. In addition, it will carry an inflation index of 1.00325 on the settlement date of July 31. With that information, we can calculate the cost of a $10,000 par value investment at this auction:
- Par value: $10,000.
- Principal purchased on settlement date: $10,000 x 1.00325 = $10,032.50
- Cost of investment: $10,032.50 x 0.99444895 = $9,976.81.
- + Accrued interest of $10.36.
In summary, an investor paid $9,976.81 for $10,032.50 on the settlement date, and from that point forward will earn accruals matching future inflation plus an annual coupon rate of 2.375%. The accrued interest will be returned at the first coupon payment on Jan. 15.
Inflation breakeven rate
At the auction’s close, the nominal 10-year Treasury note was trading with a yield of 4.70%, giving this TIPS an inflation breakeven rate of 2.26%, lower than the most recent auctions of this term. This means the TIPS will out-perform the nominal Treasury if inflation averages more than 2.26% over the next 10 years. Over the last 10 years, ending in June, inflation has averaged 3.3%.
Here is the year-to-date trend in the 10-year inflation breakeven rate, showing a surprising trend lower even amid the pressures of war and oil-supply disruptions:
Thoughts
One factor to remember is that this new TIPS is going to get hit with a principal decline of 0.35% in the month of August, based on the decline in June’s non-seasonally adjusted inflation. We can be sure that was factored into today’s auction. However, that trend could quickly reverse in future months if oil prices keep climbing, an inflationary effect that could spread across the economy.
Overall, I’d say this auction was extremely positive for investors. Yes, real yields could continue climbing higher. But a hold-to-maturity investor is assured of outpacing inflation by 2.438% over the next 10 years. That is very attractive for this term.
This TIPS will have reopening auctions on Sept. 17 and again in November, with the date not yet set. Here are auction results for the 9- to 10-year term over the last four 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.
