Positive real yield on 2013 TIPS

[Kevin M]

Today the Fidelity site is showing a positive real yield of 0.14X - 0.15X (changed while writing) on the 4/15/2013 TIPS. The inflation factor is 1.08758. Does this imply the market is predicting deflation between now and 4/15/2013? Where else can you get a positive real yield on a US treasury or federally insured security with a maturity of less than one year?

Kevin

[richard]

The WSJ is showing

Code: Select all

Maturity   Coupon     Bid      Asked    Chg  Yield*   Accrued principal
2012 Jul 15   3.000   100.08   100.08   unch.   -0.584   1278
2013 Apr 15   0.625   100.15   100.16   - 2   0.029   1087
2014 Jan 15   2.000   104.14   104.15   + 1   -0.822   1243

as of June 20.

[#Cruncher]

According to today's WSJ TIPS Quote page, the April 2013 closed down 4/32 from yesterday, boosting the yield to +0.176%. Since it matures in less than 10 months, the yield is very sensitive to price. For example depending on whether one uses the 100 11/32 bid or the 100 12/32 ask the yield is either +0.202% or 0.164%. (I calculated with http://www.ficalc.com.)

A couple of thoughts:

• Could the price be depressed because TIPS index funds are dumping it? Most of these funds follow the Barclay's index that excludes maturities under one year. The difference in yield versus the July 2013 (+0.176% vs -0.518%) seems awfully large for a difference of just 3 months.
• Over the long term investors consider a specified nominal return riskier than a specified real return because of the threat of higher than expected inflation. But could this preference be reversed over the short-term? I.e., could people consider it riskier to be guaranteed to receive inflation-adjusted dollars (where the adjustment could possibly be down) in 10 months rather than nominal dollars?

If anyone buys these, I'd be interested to know your broker, the bid/ask when you placed the order, and what price you actually got.

[Kevin M]

I was quoting the Ask yield, since that's what I'd get if I bought it. The most recent posted ask yield is 0.135%. I thought I saw it at 0.18% at one point.

The reason I posted the inflation factor is that I was thinking it reflected the downside in nominal terms, but actually it's the adjusted price, which is the price times the inflation factor. Most recent adjusted ask price quoted by Fidelity is 100.398 * 1.08758 = 109.19, so that's a possible maximum nominal loss of about 8.25% (100-109)/109. I figured this is why it seems to be on sale. However any nominal loss would reflect deflation, so the real return should still be slightly positive, no?

Of course my personal rate of inflation is not the CPI, so this still looks risky to me.

Kevin

[larryswedroe]

We have been discussing this quite a bit lately--this bond looks like the best buy BY far, based on expected inflation rate of over 2%., but you do have the RISK of deflation (and commodity prices falling sharply) due to the large INFLATION FACTOR, and that is why the real yield is relatively high

Not a free lunch

Best wishes
Larry

[Kevin M]

Thanks for chiming in Larry. Haven't you pointed out that the large inflation factor is not so much of a concern, since a nominal loss would be due to deflation, meaning that the real return still would be positive (or at least not negative)? This is exactly the point I'm most interested in, as it seems that it's the key to this apparent anomaly.

Kevin

[richard]

Large inflation factor? 1.087 doesn't seem that large, especially in light of the much higher inflation factors for the July 2012, July 2013 and Jan 2014.

I wonder if it's worth moving a chunk from Vanguard's short term bond index (0.71% SEC yld) to the April 2013.

Vanguard's current price & yield:
100.3046875/100.37109375 .25/.169

The Fed has said rather clearly that it would act to prevent deflation and I'm inclined to believe them.

[larryswedroe]

Richard
I have thought of doing the same thing. Tempting.
Larry

[richard]

Larry,

It's hard to see any real risk. On the other hand, what is the market seeing that we're not? Anomalies make me nervous.

The Fed's short term inflation forecast (PCE, not CPI) is under 2% at the moment (1.2-1.7 for 2012 and 1.5-2.0 for 2013). http://www.federalreserve.gov/monetaryp ... 120620.pdf

best,

[larryswedroe]

Richard IMO it is fear of ST deflation, would not worry about it over the long term but commodities prices collapsing as global economy slows, So that is the risk people are afraid of IMO
Larry

[richard]

Larry,

I suspect you're right

I suppose inflation of about 0.5% would leave one indifferent between ST nominals and these TIPS. I'd really hope the Fed would act at that point (and at the unemployment and growth levels that would result in ST inflation at that level), but either the market doesn't believe the Fed would act or it doesn't believe the Fed's actions would work or the pricing is an anomaly. I'm not really happy about the implications of any of those alternatives.

Oil has been dropping as the global economy slows. I haven't really been following other commodity prices.

best,

[Kevin M]

Hey you guys ... my question seems to have gotten ignored/missed

Thanks for chiming in Larry. Haven't you pointed out that the large inflation factor is not so much of a concern, since a nominal loss would be due to deflation, meaning that the real return still would be positive (or at least not negative)? This is exactly the point I'm most interested in, as it seems that it's the key to this apparent anomaly.

Kevin

[richard]

Kevin, if the idea is to lock in a real return, you can ignore the inflation factor and the level of inflation / deflation. A low inflation factor may give you a bonus if there's inflation, but a high factor won't change your real returns even if there is deflation.

If we're talking about which is a better investment over the next ten months (or the general question of TIPS v nominals), then the inflation factor and the level of inflation / deflation becomes important.

[market timer]

With such a short term instrument, accounting for seasonality is critical. Between a month that is seasonally high for CPI and another that is low, you could get what looks like implied deflation but is actually just normal seasonality. The market tends to focus on seasonally adjusted inflation rates, and so would not necessarily interpret this as a deflationary outlook.

[Kevin M]

Kevin, if the idea is to lock in a real return, you can ignore the inflation factor and the level of inflation / deflation. A low inflation factor may give you a bonus if there's inflation, but a high factor won't change your real returns even if there is deflation.

Exactly my thinking, but I think you meant that a low inflation factor gives you a bonus if there is deflation, since if the deflation exceeds the inflation factor your nominal downside is more limited, so your real return is higher.

So why is Larry talking about deflation as the risk here? It's only a risk to the nominal return, not the real return.

Kevin

[Kevin M]

So why is Larry talking about deflation as the risk here? It's only a risk to the nominal return, not the real return.

I think maybe I've got it. If there is deflation, even money earning 0% in a money market will provide a better real return than the TIPS. I actually have some in a MM, and was thinking of putting at least some of that into this TIPS.

Kevin

[richard]

I think maybe I've got it. If there is deflation, even money earning 0% in a money market will provide a better real return than the TIPS. I actually have some in a MM, and was thinking of putting at least some of that into this TIPS.

Yes. In 1% deflation, a nominal return of 0% is a higher real return than a real return of 0.75%.

If a real return of x% works for you, buying TIPS at x% is the right course. You get an adequate real return whether there's inflation or deflation and no matter what the TIPS inflation factor. You may win or lose in nominal terms, but it doesn't matter.

If you want a positive nominal return, then there is some risk to TIPS with a high inflation factor.

If you know there will be deflation, then nominals can be better than TIPS.

TIPS at 0.716% with a 1.087 factor. Nominals at 0.0213%. Note the nominal ST yield curve is smooth, while the TIPS isn't.
http://online.wsj.com/mdc/public/page/2 ... nav_2_3020
http://online.wsj.com/mdc/public/page/2 ... nav_2_3000

[Call_Me_Op]

Larry must be right. The treasury market is extremely efficient. The only risk in this bond is deflation risk, but the potential downside (over 8%) is quite steep. It is this risk that is driving the positive real yield for the issue. Still, I agree it is tempting.

[larryswedroe]

Kevin
I mention it because if you get deflation the real return to the nominal bonds could exceed the real return to the TIPS--it is the EXPECTED real return to TIPS which looks very attractive. We don't know what the ex post real return will be, and that's the risk
If you don't care about the ex post outcome and won't have "tracking error regret" than IMO you should buy the TIPS, clearly it is the best investment right now based on expected outcomes

Larry

[#Cruncher]

With such a short term instrument, accounting for seasonality is critical.

I agree. So I've made an estimate that takes seasonal adjustment into account. I've made the following assumptions:

• The June seasonally adjusted CPI-U will be down 0.3% from May, the same that May was down from April. This seems like a reasonable guess given that the price of oil has continued to fall this month.
• The seasonally adjusted CPI-U will rise at an annual rate of 2% from August through February 2013, which is the last month that will affect the inflation adjustment at maturity.
• The seasonal adjustment factors from June 2010 - Feb 2011 will apply June 2012 - Feb 2013. *

First here is may calculation of the not-seasonally adjusted CPI-U:

Code: Select all

                Seasonal       Not
  Seasonally   Adjustment   Seasonally
   Adjusted      Factor      Adjusted
  ----------   ----------   ----------
   0.99700                               0.3% decrease June (same as May)
   1.01162                               Increase July - Jan: 7 months @ 2% / year
   1.00858       99.303%      1.00155    June - Jan
   1.00165                               Increase Feb @ 2% / year
   1.01025       98.990%      1.00005    June - Feb

And now the effect on the Reference CPI that is used to determine TIPS inflation adjustment:

Code: Select all

  229.946     Mon 06/25/12 **
  229.815     Wed 08/01/12 **
  230.172     Mon 04/01/13 (229.815 X 1.00155)
  229.826     Wed 05/01/13 (229.815 X 1.00005)
  230.010     Mon 04/15/13 (average of 4/1 and 5/1)
    0.03%     % Chg 4/15/13 vs 6/25/12

So, given my assumptions (and further assuming I've done the calculations correctly ), there would be no significant inflation adjustment to these TIPS between now and maturity.

* Used Seasonal Adjustment Factors from Jun 2010 (100.349) to Feb 2011 (99.685)
Source: ftp://ftp.bls.gov/pub/special.requests/cpi/revseas_2011cpi.txt

Code: Select all

        Jan     Feb      Mar      Apr      May     Jun      Jul      Aug      Sep      Oct     Nov     Dec
      ------  ------  -------  -------  -------  -------  -------  -------  -------  ------  ------  ------
2010  99.640  99.698  100.088  100.293  100.459  100.349  100.166  100.115  100.034  99.859  99.709  99.440
2011  99.632  99.685  100.123  100.391  100.592  100.394  100.180  100.123  100.008  99.831  99.655  99.401

** Source: http://eyebonds.info/tips/2012/tips00_2012.html

Edit 12:00 PM 6/22/12: Bought at Vanguard an hour ago at price of 100.2891 = YTM of +0.263%. When placed order the spread was 0.334/0.266 so I got a YTM slightly less than the ask. But I'm still happy.

[Kevin M]

Just bought some at VG @ $100.2773. Bid/Ask 100.2265625/100.273438 (checked just after purchase). As I have seen in the past, Vanguard is showing better prices than Fidelity where current bid/ask is 100.210/100.320.

Now VG bid/ask is 100.222656/100.277344 (Yield 0.28), Fidelity is 100.203/100.313 (Yield .236).

EDIT: Just bought some at Fidelity at 100.305 (yield 0.246) (bid 100.195). By default order is entered as limit order at ask at Fidelity, but at Vanguard it is entered as a market order, and as far as I can tell there's no way to enter a limit order online. Also, minimum quantity at Vanguard is 20, minimum at Fidelity is 1.

Kevin

[market timer]

So, given my assumptions (and further assuming I've done the calculations correctly ), there would be no significant inflation adjustment to these TIPS between now and maturity.

#Cruncher, thanks for crunching the numbers, which I was too lazy to do myself. If I understand you correctly, you're saying the yield on these TIPS is consistent with a 0.3% decline in CPI in June, which is a number known with fairly high certainty, followed by a 2.0% seasonally adjusted annualized inflation rate going forward. In other words, we should consider 2.0% as a sort of breakeven seasonally adjusted inflation rate (to invert your assumption and conclusion). If realized inflation is above this rate, the investor profits.

[#Cruncher]

... we should consider 2.0% as a sort of break-even seasonally adjusted inflation rate ... If realized inflation is above this rate, the investor profits.

It looks that way. Today's yields for the 4/15/2013 nominal versus the 4/15/2013 TIPS implies a break-even CPI not seasonally adjusted change, of -0.1%. * I.e., if the Reference CPI fell 0.1% from 6/25/2012 to 4/15/2013 the nominal return on the two securities would be the same.

This is pretty close to my estimate of +0.03% for the Ref CPI change for the same period. So, if my other assumptions (and my calculations) are correct, then a 2% annual rate of change in the seasonally adjusted CPI-U from August to February is approximately the break-even.

Sooo why, one might ask, did I go ahead and buy? There are 4 reasons:

1. I don't believe my own estimate. I was trying to be conservative and my guess would be that the CPI-U will be rising more than 2% annually after the next month.
2. Regardless of how I feel about my estimate, I like having more of my fixed-income protected against unexpectedly higher inflation.
3. I shifted the funds from Vanguard Total Bond which lowers my overall interest rate risk slightly.
4. It will make it more interesting to follow the CPI over the next 8 months, knowing that I made this little bet.

* Here is how I calculate that, treating each security as a zero-coupon bond with 294 days to maturity (6/25/12 - 4/15/13):

Code: Select all

  100.17 = 100 X 1.00207^(294/365)  Nominal Treasury maturing 4/13/2013 with YTM of 0.207%
  100.27 = 100 X 1.00338^(294/365)  TIPS             maturing 4/13/2013 with YTM of 0.338%
   -0.1% = 100.17 / 100.27 - 1

Sources: WSJ Quotes Friday 6/22/2012 Nominal Treasuries and TIPS

[tarnation]

If anyone buys these, I'd be interested to know your broker, the bid/ask when you placed the order, and what price you actually got.

Fidelity at 11:22 AM ET bid/ask was 100.21/100.32, so I placed a limit order at 100.28 and was filled very quickly ( a few seconds). Then I placed an order at TDAM almost immediately afterwards. It took longer to fill, but got 100.337 on that order. Not sure if the price moved in that time, or how long it took to fill. I was away from computer for 20 mins and it was filled.

edit: looks like TDAM order went in at 11:26 was filled at 11:41.

[tarnation]

Edit 12:00 PM 6/22/12: Bought at Vanguard an hour ago at price of 100.2891 = YTM of +0.263%. When placed order the spread was 0.334/0.266 so I got a YTM slightly less than the ask. But I'm still happy.

I got a price close to that, but my yield calc was different. What is the settlement date on that?

[tarnation]

Edit 12:00 PM 6/22/12: Bought at Vanguard an hour ago at price of 100.2891 = YTM of +0.263%. When placed order the spread was 0.334/0.266 so I got a YTM slightly less than the ask. But I'm still happy.

I got a price close to that, but my yield calc was different. What is the settlement date on that?

DUH, go it. My excel spreadsheet uses TODAY()+3 for settle date, which is not correct due to the weekend.

[#Cruncher]

Bought at Vanguard an hour ago at price of 100.2891 = YTM of +0.263%.

I got a price close to that, but my yield calc was different. What is the settlement date on that?

DUH, go[t] it. My excel spreadsheet uses TODAY()+3 for settle date, which is not correct due to the weekend.

Actually, in this case today + 3 is correct because Treasuries settle the next business day which is Monday. I suspect any discrepancy your spreadsheet got was because this bond has so little time to mature and is therefore more sensitive to how the YTM (aka Internal Rate of Return) is calculated. I just calculated it again with FICALC, and using a price of 100.2891 and a 6/25/2012 settlement date, it returned a 0.266% YTM. (I don't know how I got the 0.263% reported in my previous post.)

The Excel XIRR() function also returns a YTM of 0.266% using the dates and values below:

Code: Select all

06/25/12   -100.4103 = 100.2891 + accrued interest of 0.1212 (0.3125 X 71/183)
10/15/12      0.3125
04/15/13    100.3125

[tarnation]

OK, 0.266% is what I was getting. (With a 6/25 settle date and a price of 100.2891 I was getting 0.265637% ). Oddly, I could get your 2.63% by using T+3 for settlement.

[tarnation]

They're baack. Got some today at 0.36% (100.109).

[Doc]

They're baack. Got some today at 0.36% (100.109).

You paid too much.

Maturity Coupon Bid Asked Chg Yield* Accrued principal
2013 Apr 15 0.625 100.01 100.01 unch. 0.551 1092
(Decimals are in 32nds so price was 100.0313)
Schwab is showing them with a little higher yield at 14:46 Friday.)

Thursday, November 15, 2012 closing
http://online.wsj.com/mdc/public/page/2 ... nav_2_3010

(There was no quote for the January maturity. You probably bought all of them. Or maybe there wasn't one.)

Are you making enough to buy a Starbucks?

[tfb]

Are you making enough to buy a Starbucks?

I was wondering how the positive yield translate into dollars with only less than 6 months to maturity.

[tarnation]

They're baack. Got some today at 0.36% (100.109).

You paid too much.

seems like the price always drops after I buy.

Maturity Coupon Bid Asked Chg Yield* Accrued principal
2013 Apr 15 0.625 100.01 100.01 unch. 0.551 1092
(Decimals are in 32nds so price was 100.0313)
Schwab is showing them with a little higher yield at 14:46 Friday.)

Thursday, November 15, 2012 closing
http://online.wsj.com/mdc/public/page/2 ... nav_2_3010

(There was no quote for the January maturity. You probably bought all of them. Or maybe there wasn't one.)

Are you making enough to buy a Starbucks?

If I'm lucky. I guess if I really wanted to preserve my coffee purchasing power, coffee commodity futures would be the thing.

[Doc]

Are you making enough to buy a Starbucks?

I was wondering how the positive yield translate into dollars with only less than 6 months to maturity.

If I'm lucky. I guess if I really wanted to preserve my coffee purchasing power, coffee commodity futures would be the thing.

I've been rolling a significant amount of 28 day t-bills until the fiscal cliff situtation gets more stable and I do measure the "profit" by the number of Starbucks I can buy. Unfortunately it is in the low single digits provided I save up for a couple of months. But all is not lost. I have several empty Starbucks bags I can turn in for a free "tall".

[tarnation]

Are you making enough to buy a Starbucks?

I was wondering how the positive yield translate into dollars with only less than 6 months to maturity.

If I'm lucky. I guess if I really wanted to preserve my coffee purchasing power, coffee commodity futures would be the thing.

I've been rolling a significant amount of 28 day t-bills until the fiscal cliff situtation gets more stable and I do measure the "profit" by the number of Starbucks I can buy. Unfortunately it is in the low single digits provided I save up for a couple of months. But all is not lost. I have several empty Starbucks bags I can turn in for a free "tall".

If inflation is flat until 4/15, looks like I may make enough to buy one tall Cappuccino per bond. what is the deal with the bags??

[jasonv]

I've been rolling a significant amount of 28 day t-bills until the fiscal cliff situtation gets more stable and I do measure the "profit" by the number of Starbucks I can buy. Unfortunately it is in the low single digits provided I save up for a couple of months. But all is not lost. I have several empty Starbucks bags I can turn in for a free "tall".

If inflation is flat until 4/15, looks like I may make enough to buy one tall Cappuccino per bond. what is the deal with the bags??

I'm guessing that Doc was referring to this offer:

http://blogs.starbucks.com/blogs/custom ... offee.aspx

[Bongleur]

Its a sad, sad day when grocery coupons have a higher yield than US Government paper.

[#Cruncher]

And now [my estimate of] the Reference CPI that is used to determine TIPS inflation adjustment:

Code: Select all

  229.946     Mon 06/25/12 [settlement date for purchase 6/22/2012]
  ...
  230.010     Mon 04/15/13 (average of 4/1 and 5/1)
    0.03%     % Chg 4/15/13 vs 6/25/12

So, given my assumptions (and further assuming I've done the calculations correctly ), there would be no significant inflation adjustment to these TIPS between now and maturity.

With today's release of the February CPI we know what the Reference CPI will be when these TIPS mature on 4/15/2013. At 231.16013 it's a little higher than my "guesstimate" of 230.010. (See TreasuryDirect 0-5/8% 5-YEAR TIPS Due April 15, 2013 Ref CPI and Index Ratios for April 2013.)

Edit 12:00 PM 6/22/12: Bought at Vanguard an hour ago at price of 100.2891 = YTM of +0.263%.

Here is how it will turn out (per $1,000 bond):

Code: Select all

           --- Before Inflation Adjustment ---               Index     --- After Inflation Adjustment ---
            Principal    Interest      Total      Ref CPI    Ratio     Principal     Interest      Total
           -----------   --------    ---------   ---------  -------   -----------    --------    ---------
06/25/12   (1,002.891)    (1.212)   (1,004.103)  229.94640  1.08791   (1,091.055)     (1.319)   (1,092.374)
10/15/12        -          3.125         3.125   229.67981  1.08664        -           3.396         3.396
04/15/13    1,000.000      3.125     1,003.125   231.16013  1.09365    1,093.650       3.418     1,097.068
           -----------   --------    ---------                        -----------    --------    ---------
Total          (2.891)     5.038         2.147                             2.595       5.494         8.089
YTM                                      0.266%                                                      0.922%

Since the CPI will rise about 0.5% from 229.946 on 6/25/2012 to 231.16013 on 4/15/2013, the nominal yield to maturity (YTM) at 0.922% is slightly more than the real YTM of 0.266% (calculated on bottom row with Excel XIRR function). Nothing to be excited about; but still better than nominal Treasuries maturing in 10 months were yielding last June.

2012 - 2013 Reference CPI
2012 - 2013 April TIPS' Index Ratios