What is meaning of identical yield on 5yr and 10yr TIPS ?

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Dudley
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What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by Dudley » Tue Jul 24, 2018 1:06 am

The real yields for 5yr and 10yr TIPS are almost exactly the same (~0.75%). What is the market saying ? That real yields are not expected to rise, and furthermore the 5yr is likely to fall ?

Valuethinker
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by Valuethinker » Tue Jul 24, 2018 2:58 am

Dudley wrote:
Tue Jul 24, 2018 1:06 am
The real yields for 5yr and 10yr TIPS are almost exactly the same (~0.75%). What is the market saying ? That real yields are not expected to rise, and furthermore the 5yr is likely to fall ?
It's possible to read too much into this.

Formally, the market is saying the Internal Rate of Return of the cashflows from the 2 securities is identical (definition of Yield to Maturity) under the assumption that the coupons can also be reinvested at the same rate.

A nearly flat yield curve might mean that the market expects short term interest rates to go up relative to long term interest rates.

From an investor perspective the curve is saying that you are not being rewarded for locking up your money for longer. However given that normally short interest rates are lower than long, another way of looking at this is that you are not paying a penalty to go short.

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#Cruncher
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by #Cruncher » Tue Jul 24, 2018 6:47 am

Dudley wrote:
Tue Jul 24, 2018 1:06 am
The real yields for 5yr and 10yr TIPS are almost exactly the same (~0.75%).
They are close; but not "almost exactly the same". According to the WSJ 7/23/2018 TIPS Quotes the July 2028 is yielding 0.830%, 0.135% points more than the 0.695% yield of the July 2023. The following table shows that the current 1-10 year TIPS yield curve is shallow, but not quite flat.

Code: Select all

                                vs Prior
  Matures     Coupon    Yield       Year
----------    ------    ------    ------
07/15/2019    1.875%    0.660%
07/15/2020    1.250%    0.688%    0.028% 
07/15/2021    0.625%    0.705%    0.017% 
07/15/2022    0.125%    0.688%   (0.017%)
07/15/2023    0.375%    0.695%    0.007% 
07/15/2024    0.125%    0.738%    0.043% 
07/15/2025    0.375%    0.760%    0.022% 
07/15/2026    0.125%    0.792%    0.032% 
07/15/2027    0.375%    0.811%    0.019% 
07/15/2028    0.750%    0.830%    0.019%

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vineviz
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by vineviz » Tue Jul 24, 2018 6:53 am

Valuethinker wrote:
Tue Jul 24, 2018 2:58 am

From an investor perspective the curve is saying that you are not being rewarded for locking up your money for longer.
Your reward is “free” protection against 5-year rates being lower in 2023 than they are today, something a flat yield curve (which we don’t actually have, but still...) tells us that the market thinks is somewhat likely.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

grok87
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by grok87 » Tue Jul 24, 2018 7:15 am

The best way to think about this is to start with nominal treasuries and then think about break-even inflation (bei) rates.

5 year nominal 2.82%
10 year nominal 2.96%

5 year tips 0.81%
10 year tips 0.84%

So 5 year bei = 2.01%
10 year bei = 2.12%
5x5 bei = 2.23%

5 year bei is for the period 2018-2023
10 year bei is for 2018-2028
5x5 bei is for the period 2023-2028

So what bond markets are telling you is that they think inflation will come in at the feds target 2.0% for the next 5 years. But for the 5 years after that they think inflation will run hot at 2.23%. This could be due to tariffs or fear of a trade war etc.

Now let’s look at 30 years
30 year nominal 3.09%
30 year tips 0.96%
30 year bei 2.13%
20x10 bei 2.13%

So for the period 2028-2048 markets are expecting inflation at 2.13%. Ie they think the elevated inflation for 2023-2028 will be a passing thing.


Cheers,
Grok
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Doc
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by Doc » Tue Jul 24, 2018 8:32 am

The breakeven number includes a risk factor and a liquidity factor as well as an inflation factor. With the BEI this low it's difficult to make good assessments from the numbers.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by #Cruncher » Tue Jul 24, 2018 11:09 am

grok87 wrote:
Tue Jul 24, 2018 7:15 am
The best way to think about this is to start with nominal treasuries and then think about break-even inflation (bei) rates. [underline added]
Huh? The original post refers to the yield curve for TIPS. Looking at break-even inflation rates across maturities tells us about the difference in yield curves between nominal Treasuries and TIPS, an interesting but quite different subject.
grok87 in same post wrote:So what bond markets are telling you is that they think inflation will come in at the feds target 2.0% for the next 5 years. But for the 5 years after that they think inflation will run hot at 2.23%.
I don't think the data support this conclusion, Grok. Comparing 8/15 nominal Treasuries [1] to 7/15 TIPS [2] shows almost identical BEI rates of 2.137% for 2023 and 2.140% for 2028. Extending the comparison to include 2/15 maturities 2040 - 2047 shows the BEI rate staying in a small 2.12% to 2.16% range for 2023 - 2047.

Code: Select all

---- Nominal Treasury ---    ---------- TIPS ---------
 Matures   Coupon   Yield     Matures   Coupon   Yield    BEI

Code: Select all

8/15/2019   0.750   2.431    7/15/2019   1.875   0.660   1.771
8/15/2020   1.500   2.637    7/15/2020   1.250   0.688   1.949
8/15/2021   2.125   2.738    7/15/2021   0.625   0.705   2.033
8/15/2022   1.625   2.792    7/15/2022   0.125   0.688   2.104
8/15/2023   2.500   2.832    7/15/2023   0.375   0.695   2.137 <---
8/15/2024   2.375   2.896    7/15/2024   0.125   0.738   2.158
8/15/2025   2.000   2.922    7/15/2025   0.375   0.760   2.162
8/15/2026   1.500   2.950    7/15/2026   0.125   0.792   2.158
8/15/2027   2.250   2.964    7/15/2027   0.375   0.811   2.153
8/15/2028   5.500   2.970    7/15/2028   0.750   0.830   2.140 <---

2/15/2040   4.625   3.052    2/15/2040   2.125   0.931   2.121
2/15/2041   4.750   3.069    2/15/2041   2.125   0.936   2.133
2/15/2042   3.125   3.084    2/15/2042   0.750   0.961   2.123
2/15/2043   3.125   3.094    2/15/2043   0.625   0.963   2.131
2/15/2044   3.625   3.097    2/15/2044   1.375   0.968   2.129
2/15/2045   2.500   3.103    2/15/2045   0.750   0.972   2.131
2/15/2046   2.500   3.107    2/15/2046   1.000   0.975   2.132
2/15/2047   3.000   3.100    2/15/2047   0.875   0.971   2.129
  1. From WSJ Treasury Quotes 7/23/2018. I chose the August 15 maturity of nominal Treasuries because it is the one that is closest to July 15 for all the years 2019 to 2028. E.g., there are no 7/15 nominal Treasury maturities beyond 2021, 7/31 maturities beyond 2024, or 6/30 maturities beyond 2025.
  2. TIPS yields are from the same WSJ 7/23/2018 TIPS Quotes that I used in my previous post.

grok87
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by grok87 » Tue Jul 24, 2018 11:12 am

Interesting.

Looking at a Bloomberg terminal gives 2.0% for the 5 year break even inflation.

I think you want to compare the on the run bonds both tips and nominals and then somehow adjust for maturity difference

Here’s further support for the idea that 5x5 bei is looking a Little hot at 2.20 ish.


https://fred.stlouisfed.org/series/T5YIFR
Keep calm and Boglehead on. KCBO.

garlandwhizzer
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by garlandwhizzer » Tue Jul 24, 2018 1:19 pm

Based on the difference between Treasury yields and TIPS yields there seems to be a consistent expectation of inflation over the next 5, 10, and even 30 years at slightly more than 2%. Little expected change in inflation which remains low and stable by long term historical standards for 5, 10, or 30 years. Interestingly over the last 12 months as measured by CPI, the US inflation rate has been 2.9%, higher than any of these expectations. The market believes that strong secular forces--demographics, technology advancement, and better economic management by central banks--will succeed in killing the inflation/deflation demons and we will have continued slow steady growth without the severe distortions of the past.

During the 12 years of the Great Depression expectations for future inflation were zero or negative. During the severe inflation of the 1970s and early 1982s, annual future inflation rate was expected to be double digit for the foreseeable future. 30 year Treasuries reflected those expectations and those who bought them in 1982 were guaranteed a 14.8% yield for 30 years. So much for what the market expects about inflation or anything else over a long time period. I don't believe that anyone can accurately predict anything about financial markets over 30 years, 10 years, or even 5 years. There are too many variables both known and unknown presently that play into that equation. No one now expects inflation to heat up significantly in the future, nor do they expect a deflationary crisis. Bogle says about predictions in general, "Don't count on it." I believe that to be sound advice from a giant. An all weather portfolio with some asset protection for inflation and for deflation is IMO the best insurance against the inherent uncertainty of the future. Current predictions about future inflation may in the end turn out to be as laughable as they were at times in the past.

Garland Whizzer

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SimpleGift
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by SimpleGift » Tue Jul 24, 2018 1:54 pm

garlandwhizzer wrote:
Tue Jul 24, 2018 1:19 pm
So much for what the market expects about inflation or anything else over a long time period.
A point worth emphasizing. If one compares actual inflation rates with forecasted inflation rates in history, it's fairly clear that most changes to inflation are actually unexpected (chart below).
Just eyeballing the chart, there appears to be quite a bit of "anchoring" in the forecasted inflation rates historically — i.e., forward estimates appear largely based on actual inflation of the recent past — and are thus often inaccurate.
Cordially, Todd

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FIREchief
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by FIREchief » Tue Jul 24, 2018 2:42 pm

SimpleGift wrote:
Tue Jul 24, 2018 1:54 pm
A point worth emphasizing. If one compares actual inflation rates with forecasted inflation rates in history, it's fairly clear that most changes to inflation are actually unexpected (chart below).
Yep. Inflation is that bus that you don't see coming until you're hit (and it's often a string of busses).
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

acegolfer
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by acegolfer » Tue Jul 24, 2018 3:05 pm

Research "term spread", which is the interest rate difference at 2 different maturities. Also research "yield curve".

FYI, the term spread between 5 and 10 yr (right side of the yield curve) is traditionally very small, close to 0%. OTOH, the term spread between <1 yr and 10yr varies over time.

gmaynardkrebs
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by gmaynardkrebs » Tue Jul 24, 2018 4:31 pm

Valuethinker wrote:
Tue Jul 24, 2018 2:58 am

From an investor perspective the curve is saying that you are not being rewarded for locking up your money for longer. However given that normally short interest rates are lower than long, another way of looking at this is that you are not paying a penalty to go short.
Yes, you are being rewarded, and you may pay a penalty for being short. Were it were otherwise, the prices for longer maturities would adjust lower. What it means is that the risk of rates being lower at in the future is so high that investors are willing to pay a high price for longer maturities to avoid the reinvestment risk of shorter maturities. Nothing more, nothing less. Investors are not stupid.

grok87
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Re: What is meaning of identical yield on 5yr and 10yr TIPS ?

Post by grok87 » Tue Jul 31, 2018 6:33 pm

well the inverted (real) yield curve is here. 5 year tips yield 0.84% and 10 year tips 0.83%

https://www.bloomberg.com/markets/rates ... t-bonds/us
Keep calm and Boglehead on. KCBO.

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