Why does the US issue TIPS?

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Jacobkg
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Why does the US issue TIPS?

Post by Jacobkg »

I understand why individual investors like TIPS, but what is the advantage to the US? Why not only sell nominal securities?
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Re: Why does the US issue TIPS?

Post by White Coat Investor »

Jacobkg wrote:I understand why individual investors like TIPS, but what is the advantage to the US? Why not only sell nominal securities?
Because if they can keep rates low (as planned) they hardly have to pay anything for these. And if rates go up, so does the tax revenue to pay these things off. In fact, like all bonds, TIPS, at least in a taxable account, become worse investments as the rates get higher since we're taxed on nominal gains, not real ones.
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Post by dumbmoney »

You could also ask, why sell nominal bonds? It seems like there should be a simple answer, but there isn't. One common but wrong answer is, "to finance spending". That doesn't apply to governments that make their own money, like the U.S., Japan, UK, etc.

From a risk minimization point of view, long term nominal bonds are best. That's because for the government, financing risk equals inflation risk, and long term nominals lose value when the risk appears.

From a cost minimization point of view, it's best not to issue bonds of any kind. Or only very short term bonds, which are the functional equivalent of interest-bearing cash.
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Re: Why does the US issue TIPS?

Post by Valuethinker »

Jacobkg wrote:I understand why individual investors like TIPS, but what is the advantage to the US? Why not only sell nominal securities?
In finance if you can create a product that does not exist, that investors desire, then you can make money.

For the US that translates as a lower cost of funding and hence lower cost to the taxpayer.

It also has a game theoretic element. It's a credible signal about inflation: if US inflation outcome is less than the market expectations, then the US Treasury has made money for the taxpayer.

US Treasury is overly conservative on TIPS issuance. UK indexed linked gilts are c. 25% of all outstanding government debt. UK actuarial rules create a large domestic market of pension funds and insurance companies (buying for annuities, which are what PFs do when someone retires).
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Post by fredflinstone »

This paper argues that the U.S. government should not issue TIPS:
https://docs.google.com/viewer?url=http ... .pdf&pli=1

Here is the concluding paragraph:
Finally, our results point out that the ongoing issuance of TIPS by the Treasury is in itself a puzzle. This is because the Treasury not only gives up a fiscal hedging option by issuing TIPS, it also leaves billions of dollars on the table by issuing securities that are not as highly valued by the market as nominal Treasury bonds.
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Post by Valuethinker »

fredflinstone wrote:This paper argues that the U.S. government should not issue TIPS:
https://docs.google.com/viewer?url=http ... .pdf&pli=1

Here is the concluding paragraph:
Finally, our results point out that the ongoing issuance of TIPS by the Treasury is in itself a puzzle. This is because the Treasury not only gives up a fiscal hedging option by issuing TIPS, it also leaves billions of dollars on the table by issuing securities that are not as highly valued by the market as nominal Treasury bonds.
1. The US Treasury created a pure public good by creating a previously non-existent inflation hedge. Analogies to building the Interstate Highway System or the existence of the SEC.

2. the date of the article does not include the much lower real interest rates that now pertain. TIPS were new, they paid high real interest rates. They do not do so now.

So the second objection is much less so, if at all.

3. on the first objection, what the Treasury is giving up is the ability to 'surprise' the nominal bond market with a higher than expected inflation rate.

In the long run, it's doubtful whether you can play that game forever-- you get constantly accelerating inflation expectations.

And it's counter to the game theory point about credible signals re future inflation.
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Post by richard »

The GAO recently did a report on TIPS http://www.gao.gov/new.items/d09932.pdf
In January 1997, Treasury introduced an inflation-indexed security—TIPS. Treasury’s stated objectives were to both raise the national savings rate and to reduce the federal government’s cost of borrowing. TIPS offer inflation protection to investors who are willing to pay a premium for this protection in the form of a lower interest rate.
For a sufficiently lengthy time horizon the cost of Treasury Inflation
Protected Securities (TIPS) relative to nominal Treasury securities should
be the same when calculated on both an ex-ante (before the fact) and expost (after the fact) basis, all else equal.
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Post by Valuethinker »

richard wrote:The GAO recently did a report on TIPS http://www.gao.gov/new.items/d09932.pdf
In January 1997, Treasury introduced an inflation-indexed security—TIPS. Treasury’s stated objectives were to both raise the national savings rate and to reduce the federal government’s cost of borrowing. TIPS offer inflation protection to investors who are willing to pay a premium for this protection in the form of a lower interest rate.
For a sufficiently lengthy time horizon the cost of Treasury Inflation
Protected Securities (TIPS) relative to nominal Treasury securities should
be the same when calculated on both an ex-ante (before the fact) and expost (after the fact) basis, all else equal.
The government (taxpayer) has paid an illiquidity premium on TIPS bonds-- the solution to which is of course to offer more, and as closely fungible as possible (ie a few large issues).

To the extent that the market systematically misjudges inflation (too high or too low-- if indeed it does do) TIPS will have a long run different return than nominal bonds.

However it's likely that the outcomes will be dispersed both too high and too low, so it should even out, at least as best as I know.

What cannot be ignored is the value the US government has created by issuing TIPS. It's a pure public good, it has created a risk free USD inflation hedge.

The recent proposal that the US government offer longevity bonds (in effect, annuities) will doubtless fail for political reasons, but would be another step forward in that regard. Arguably in Social Security, the US government already does offer such a product, but in a fairly restricted form.

Longevity insurance is just not that easy to obtain in private markets- and what if you had bought it from AIG?

So one of the worst risks investors face, they cannot hedge. Now the UK consols were, legally, annuities of perpetual term, so again there is precedent.

UK Treasury keeps saying longevity bonds would be too expensive a form of borrowing.

With TIPS it took a brave and determined (against institutional opposition) Treasury Secretary to drive it through (Rubin). Despite the existence of ample international precedents (and even a few dating back in US history).

Longevity bonds we would be a whole 'nother leap of faith forward.
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Post by marco100 »

Assume that out of all investors, there is NOT some subset of investors who are willing to pay a premium for risk-free securities which isolate inflation, because these investors have more risk-aversion to inflation.

If the above is true, there would be no market for TIPS. But, since there is a market for TIPS, by logical contradiction, we have proved that there are some investors who will pay a premium over nominals for the ability to isolate the inflation component of returns.

IOW the government actually gets extra money for selling TIPS.

Believe it or not.
What cannot be ignored is the value the US government has created by issuing TIPS. It's a pure public good, it has created a risk free USD inflation hedge.

No, this cannot be true (that is, the "pure public good" part) if the market for U.S. securities is reasonably efficient.

Like I bonds, the real rate of return on TIPS of all durations will inevitably, over time, trend towards 0%. Because TIPS will be favored by that subset of investors who are most concerned about protecting against unexpected inflation/preserving principle.

WHY are there still people out there, buying any I bonds at all, when the real rate of return is zero?

It's because the I bonds isolate the inflation protection.

As a matter of fact, there's no reason, other than psychological, that the treasury couldn't simply ONLY offer zero real return tips and I bonds. These would be "pure" inflation protection. People could then buy as many I bonds and/or TIPS as they think they need to protect whatever portion of their portfolio they want to protect against inflation. The rest of the portfolio, that is, the portion upon which they want to see real growth, would have to be put into something else.
Last edited by marco100 on Wed Mar 02, 2011 6:55 am, edited 1 time in total.
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Post by Valuethinker »

marco100 wrote:Assume that out of all investors, there is NOT some subset of investors who are willing to pay a premium for risk-free securities which isolate inflation, because these investors have more risk-aversion to inflation.

If the above is true, there would be no market for TIPS. But, since there is a market for TIPS, by logical contradiction, we have proved that there are some investors who will pay a premium over nominals for the ability to isolate the inflation component of returns.

IOW the government actually gets extra money for selling TIPS.

Believe it or not.
Indeed. Because it meets an unmet capital market need-- for default risk free, pure inflation hedging.

What I would like to see the US government do is raise a lot of long TIPS, and maybe do a 50 year one a la the UK.

The capital markets would create products of shorter term derived from these (a la Merrill Lynch creating the STRIPped TBond). But the US govenrment would use its unique position to create very long term inflation protected securities.

If it could do, say, a 50 year TIP with $50bn (perhaps by issuing it in identical tranches, as and when there was demand at auction, but all with the same maturity date) it might overcome some of the illiquidity premium problem. Investors would not hoard the 50 year TIPS (the usual problem with long TIPS issuance) because they would know the Treasury would always create more supply in the future, so the premium would be reduced.

It would also be as good as we have (not very good, but as good as we have) measure of pure very long run USD inflation expectations. That additional transparency to markets would create efficiency in and of itself (providing that bond were sufficienly liquid).

If it sold annuities on the same basis (there is an op ed piece in the last few days about this: I think I read it in the Herald Tribune) then it would also have created a longevity hedge.
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Post by marco100 »

The government hasn't yet figured out that offering anything above a zero percent real interest rate on TIPS is overpaying.

If the objective is to sell inflation protection, then there is no need for combining any real return with it.

People who want the inflation protection will buy the TIPS; people who want real return will buy something else. In effect, TIPS which offer inflation protection + a real return above zero are actually a "hybrid" security. Maybe that's why their behavior is so peculiar sometimes?
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Post by Valuethinker »

marco100 wrote:The government hasn't yet figured out that offering anything above a zero percent real interest rate on TIPS is overpaying.

If the objective is to sell inflation protection, then there is no need for combining any real return with it.

People who want the inflation protection will buy the TIPS; people who want real return will buy something else. In effect, TIPS which offer inflation protection + a real return above zero are actually a "hybrid" security. Maybe that's why their behavior is so peculiar sometimes?
I don't think that is correct, in that all debt securities (other than cash) have to offer a prospective real rate of return to attract investors.

Even in a default risk free US government security, there is interest rate risk (real and nominal): interest rates could go up in the future.

If you have persistent long term real interest rates of zero or below, then you get weird outcomes. Basically you get Japan:

- an incredible asset price bubble
- a decades long slump when that pops

It's one thing for UK indexed linked gilts (which don't incur tax on the appreciation of the capital value) to trade around 0.75-1.25% real. It's another thing for real interest rates (long run) to be persistently negative.
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Post by fredflinstone »

marco100 wrote:The government hasn't yet figured out that offering anything above a zero percent real interest rate on TIPS is overpaying.
as it happens, zero is roughly the real interest rate on a 5-year TIP.

If the government tried to pay a rate of zero on a longer-term TIP bond, no one would buy it. That is why the government pays more than zero on long-duration TIPS.
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Post by Valuethinker »

fredflinstone wrote:
marco100 wrote:The government hasn't yet figured out that offering anything above a zero percent real interest rate on TIPS is overpaying.
as it happens, zero is roughly the real interest rate on a 5-year TIP.

If the government tried to pay a rate of zero on a longer-term TIP bond, no one would buy it. That is why the government pays more than zero on long-duration TIPS.
Is the US government attaining 0% rates for TIPS at auction though?

That is what is relevant to funding costs.

This is a secondary market quote?

Generally, it seems to me, that at the long end the ability to borrow at 2% real interest rate is a pretty good bargain for the US taxpayer. Perhaps contradictorily, the ability to lend for that long at that real rate is also good for the investor.

If we lived in a 'rational' investing world, then US government debt would be almost 100% real return securities, and we would be arguing now about whether it was worth them issuing *nominal* securities.

investors should care about real liabilities, and real assets, not nominal ones.

There was a promising idea that mortgages should be structured as real securities, rather than nominal ones. If housing prices had stayed high enough, perhaps that would have happened (illiquidity costs would have killed it *unless* someone like Freddie/ Fannie/ CMHC etc. kicked it off).

As a prof of mine in undergrad economics used to say: 'if Adam Smith had started with an industry with imperfect competition, the Nobel Prizes now would be for people who discovered what pure competition might look like'.
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Post by grayfox »

marco100 wrote:The government hasn't yet figured out that offering anything above a zero percent real interest rate on TIPS is overpaying.

If the objective is to sell inflation protection, then there is no need for combining any real return with it.

People who want the inflation protection will buy the TIPS; people who want real return will buy something else. In effect, TIPS which offer inflation protection + a real return above zero are actually a "hybrid" security. Maybe that's why their behavior is so peculiar sometimes?
The government does not set the real return on TIPS. The market sets the real return. They sell at auction when issued and then the sell in the secondary market.

Even if henceforth they only offered TIPS with 0% coupon, the market would decide if they will accept zero return (bid par), demand a real return (discount) or even accept a negative real return (premium).

Right now the 2041 2.125% TIPS has 104.03 price and real YTM 1.943%. If investors were willing to accept a zero YTM they would just bid the price up to about 164. What the government has or hasn't figured out has nothing to do with it.

http://online.wsj.com/mdc/public/page/2 ... nav_2_3020
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Re: Why does the US issue TIPS?

Post by Doc »

Jacobkg wrote:I understand why individual investors like TIPS, but what is the advantage to the US? Why not only sell nominal securities?
IIRC way back at the beginning there were two reasons for offering "Treasury Inflation Indexed Securities".

1) To save the inflation risk premium on nominal Treasuries.

2) To provide a "market" based estimate for inflation in order to better economic forecasts.

Given the liquidity issues associated with TIPS neither of these original reasons may be valid now.
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Post by dmcmahon »

marco100 wrote:The government hasn't yet figured out that offering anything above a zero percent real interest rate on TIPS is overpaying.

If the objective is to sell inflation protection, then there is no need for combining any real return with it.

People who want the inflation protection will buy the TIPS; people who want real return will buy something else. In effect, TIPS which offer inflation protection + a real return above zero are actually a "hybrid" security. Maybe that's why their behavior is so peculiar sometimes?
Well, I don't agree. I personally do own TIPS, as well as equities, and I can tell you that when the real yields are below my threshold I push back from the table. The "riskless" aspect of the TIPS real return is only worth so much, especially when you consider the unfavourable tax treatment the inflation adjustment gets.
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Post by beareconomy »

Is it possible on an original issue of a TIP for the fixed rate to be negative like it can be on a reissue?
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Post by Doc »

dmcmahon wrote: ... I can tell you that when the real yields are below my threshold I push back from the table.
How un-Boglelike. I agree completely.
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Post by Alex Frakt »

It could not be simpler. In theory, people should be willing to pay a higher price (aka, accept a lower interest rate) for TIPS's explicit interest rate hedge. After people got over their initial unfamiliarity with the product, that is exactly what has happened.

This saves the US government (aka US people) some of the cost of servicing our debt. Possibly paraphrasing Everett Dirksen, "Ten billion here, ten billion there. Pretty soon, you are talking about real money."
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Post by trackermike »

+1 on this very stimulating topic!

It was mentioned before about issuing 50-year TIPS to get an idea of Long run inflaction expectations. Wouldn't the 30-year provide 99% of this information already? Or are there inconsistencies that I am unaware of.

thanks,
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Post by Valuethinker »

trackermike wrote:+1 on this very stimulating topic!

It was mentioned before about issuing 50-year TIPS to get an idea of Long run inflaction expectations. Wouldn't the 30-year provide 99% of this information already? Or are there inconsistencies that I am unaware of.

thanks,
Mike
Maybe. And if the 50 year was illiquid, 30 year would be a purer measure (and TIPS aren't a great forecast of future inflation in general, just one of the best we have).

The UK government issued the 50 year Index Linked Gilt in response to an institutional need to have an inflation-linked liability hedge (UK pensions are required to match inflation up to a certain percentage).

However even a 30 year TIPS has some degree of time value in it. A 50 year one would, hand wavingly, have 1/3rd less (the difference between a 30 year amortisation and a 50 year one).

I think it would be worth trying. As I said, via sales as a series of tranches of the same bond, you could in time create quite a deep and liquid pool of securities.
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Post by LH »

dumbmoney wrote:You could also ask, why sell nominal bonds? It seems like there should be a simple answer, but there isn't. One common but wrong answer is, "to finance spending". That doesn't apply to governments that make their own money, like the U.S., Japan, UK, etc.

From a risk minimization point of view, long term nominal bonds are best. That's because for the government, financing risk equals inflation risk, and long term nominals lose value when the risk appears.

From a cost minimization point of view, it's best not to issue bonds of any kind. Or only very short term bonds, which are the functional equivalent of interest-bearing cash.
Consumption=Production.

Short term, you can print money. Zimbabwe can print money.

The reason governments must borrow money, on net aggregate, is that their consumption is greater than their production. You cannot consume from thin air.

The US needs to borrow money(ie borrow someone elses current production) to finance their current spending in excess of their current production.

Long term, production=consumption. Money is a scrap of paper, exchange mechanism, that represents the REAL thing, the production of goods and services, and the consumption of goods and services........
One common but wrong answer is, "to finance spending". That doesn't apply to governments that make their own money, like the U.S., Japan, UK, etc.
Neither US nor Japan, nor Greece, Ireland, Iceland, portugal, can pull that off long term, as soon as the counterparty realizes/doubts ability to pay back, not in scraps of paper, but in the actual goods and services those scraps of paper represent, its game over. US has more leeway, has more rope to hang itself certainly, but at the end of the longer US rope is still the noose.

Deficit Spending=consumption of goods and service that are PRODUCED by someone, by WORK now(or land etc).

That someone, is not gonna take money that is not backed by goods and services in the future. That is the ONLY reason, they exchange thier current production/work/good/service so we can consume it, they are charging interest, and expect we will work and produce more for THEM in the future. Its not the scraps of paper called "money" they are interested in or trading for, its the promise of future production, goods(land), services, etc going to them in the future.

Are the chinese, exporting tons and tons of stuff to Zimbabwe for their funny money(if it still exists)? No. Because that money is not backed by much anything. There is no expected return of goods services in the future of zimbabwe money, there is expected loss and fast. If the US simply decides to print 14 one trillion dollar bills, is the debt solved? No. It would be an unmitigated disaster. Heck, why not just print 300 million trillion dollar bills, give one to each US citizen, we would all be trillionaires! Rich! We can just print money, to finance spending, and all our needs will be met.

No. Does not work. We have to borrow to finance real spending. We cannot print it, except marginally due to reserve currency status. We have to borrow others current Production to finance our current excess consumption.

To think otherwise, is to think that if the government prints a trillion dollar bill, one trillion dollars worth(before the trillion was printed) of new goods and services magically would appear out of thin air! (Again, this kinda happens at the margin some, Seigniorage, etc.) But this is really a "rent" we charge for the service of being dependable store of value. It we are not a store of value, no ones gonna pay that rent....

The consumption=Production equation is law in the end. Money is just an exchange mechanism. Printing more of it does nothing real in the end. Its goods(land/cars/peanut butter) and services that are really being traded.

The books:
economics in one lesson - hazzlit
naked economics
Globalizing Capital: A History of the International Monetary System Eichengreen

Come to mind.
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Post by grberry »

The ability to compare TIPS yield and nominal treasury yield has been of value to me at work. I can turn to customers and say that the difference is the market's current expectation of inflation. This is helpful when we are negotiating the inflation language in our contracts.
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Post by bobcat2 »

Doc writes.
IIRC way back at the beginning there were two reasons for offering "Treasury Inflation Indexed Securities".
I believe that originally in 1997 the bonds were known as "Treasury Inflation Targeted Securities". However, the associated acronym for those securities was unfortunate and several church groups, among others, complained. :lol: The Treasury responded expeditiously by quickly and quietly changing the name and associated acronym.

I leave it as an exercise for the inquiring mind of the interested reader to determine the original associated acronym. :wink:

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Post by Watty »

To oversimplify;

1) If inflation is 2% and a 30 year $100K TIPS has a coupon of 2%, then for the first 29 years the cost to the government is $2,000 per year for a total cost of $58,000

2) A 4% 30 year $100K treasury bond will cost the government $4,000 per year for the first 29 years for a total cost of $116,000

It may or may not be the best choice, but for the first 29 years the TIPS is sure a lot easier to pay from a cash flow standpoint.


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Post by #Cruncher »

beareconomy wrote:Is it possible on an original issue of a TIP for the fixed rate to be negative like it can be on a reissue?

Assuming by "fixed rate" you mean the real yield to maturity, I don't see why not. But your question made me think of a related one: assuming yields are close to or below 0% could/would the Treasury issue a TIPS with a zero coupon? It would simplify bookkeeping.
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Post by tetractys »

Anyone have any insight on whether or not TIPS carry an element of inflation control along with their issuance? -- Tet
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Post by joe8d »

The ability to compare TIPS yield and nominal treasury yield has been of value to me at work. I can turn to customers and say that the difference is the market's current expectation of inflation.
I don't know if that's true in this current environment.Given the number of of flights to quality (Treasuries) that have been occurring over the last couple of years may well have distorted that concept.
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Post by grberry »

joe8d wrote:
The ability to compare TIPS yield and nominal treasury yield has been of value to me at work. I can turn to customers and say that the difference is the market's current expectation of inflation.
I don't know if that's true in this current environment.Given the number of of flights to quality (Treasuries) that have been occurring over the last couple of years may well have distorted that concept.
Not really. If the "smart" boys on Wall Street expected the difference in their yields was different from future inflation, they would buy one and sell the other until the difference in yields matched their inflation expectation. (They would be engaging in arbitrage.)
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Post by Doc »

#Cruncher wrote:
beareconomy wrote:Is it possible on an original issue of a TIP for the fixed rate to be negative like it can be on a reissue?

Assuming by "fixed rate" you mean the real yield to maturity, I don't see why not. But your question made me think of a related one: assuming yields are close to or below 0% could/would the Treasury issue a TIPS with a zero coupon? It would simplify bookkeeping.

•Competitive bidders specify the discount rate or yield they wish to receive.
http://www.treasurydirect.gov/indiv/res ... ndepth.htm
Minimum Interest Rate:
This final rule amendment, (PDF format, file size-51KB, uploaded 3/01/11) effective April 1, 2011, establishes a minimum interest rate of 1/8 of one percent for all new Treasury fixed-principal ("nominal") and inflation-protected note and bond issues
http://www.treasurydirect.gov/instit/st ... uctreg.htm
The interest rate we establish produces the price closest to, but not above, par that corresponds to the yield awarded to successful competitive bidders.
http://www.treasurydirect.gov/instit/st ... 012011.pdf

Hmmnn! Above quotes seem to indicate that the rules do not accommodate negative yields real or nominal. Interest rate must be >0 and price must be less than or equal to par and that means YTM is greater than zero.

It would be an interesting dilemma if it happened. I suspect that the Treasury would be forced to not sell any securities but on the other hand given how "rules" were twisted following the financial meltdown I guess anything is possible. :roll:
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Post by grok87 »

tetractys wrote:Anyone have any insight on whether or not TIPS carry an element of inflation control along with their issuance? -- Tet
I don't think at current levels of TIPs issuance. Because they are not a huge part of outstanding treasury debt. But i think the fact that us debt is fairly short term in duration does give the treasury an incentive to make sure inflation doesn't get out of hand...
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Post by Valuethinker »

grok87 wrote:
tetractys wrote:Anyone have any insight on whether or not TIPS carry an element of inflation control along with their issuance? -- Tet
I don't think at current levels of TIPs issuance. Because they are not a huge part of outstanding treasury debt. But i think the fact that us debt is fairly short term in duration does give the treasury an incentive to make sure inflation doesn't get out of hand...
cheers,
The argument not to fund far out along the curve is

1. higher cost to US taxpayer

2. US will return to fiscal prudence and repay debt, long debt will turn out to be expensive in that case

It's nonsense. UK has an average maturity of debt of 14 years, US around 5 I believe (along with most other developed nations).

If you are a high credit rating sovereign borrower you should borrow essentially forever, or at least as long as you can and the market demands.

US 30 and 40 year TIPS should show significant demand because of their hedging properties, and it's almost impossible to buy private sector debt 30 years + in any form (let alone inflation linked).

You reduce the risk of a liquidity/ rollover crunch by funding long.
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Post by #Cruncher »

Doc wrote:http://www.treasurydirect.gov/instit/st ... 012011.pdf
Hmmnn! Above quotes seem to indicate that the rules do not accommodate negative yields real or nominal. Interest rate must be >0 and price must be less than or equal to par and that means YTM is greater than zero. It would be an interesting dilemma if it happened.
Thanks for researching this, Doc. I read a little further in the PDF you reference and came upon this (2nd page, 1st column), which explains how they get out of the dilemma:
II. Establishing a Minimum Interest Rate In an extremely low interest rate environment, a note or bond auction could result in an interest rate lower than Treasury’s 1⁄8 of one percent interest rate increment. If that were to happen, under the current methodology the new security would be issued with a zero percent interest rate and would have no semi-annual interest payments. Treasury is amending the UOC because we believe it is preferable that Treasury notes and bonds pay regular, semi-annual interest payments.

III. Amendment to the Rule Accordingly, Treasury is amending paragraph (b) of 31 CFR 356.20 to state that if a Treasury note or bond auction results in a yield lower than 0.125 percent, the interest rate will be set at 1⁄8 of one percent with the price adjusted accordingly (i.e., at a premium). This change applies to all new marketable Treasury note and bond issues: Treasury fixed-principal 5 (also referred to as nominal) notes and bonds as well as Treasury inflation-protected notes and bonds. (emphasis added)
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Post by Doc »

#Cruncher wrote:
Doc wrote:http://www.treasurydirect.gov/instit/st ... 012011.pdf
Hmmnn! Above quotes seem to indicate that the rules do not accommodate negative yields real or nominal. Interest rate must be >0 and price must be less than or equal to par and that means YTM is greater than zero. It would be an interesting dilemma if it happened.
Thanks for researching this, Doc. I read a little further in the PDF you reference and came upon this (2nd page, 1st column), which explains how they get out of the dilemma:
II. Establishing a Minimum Interest Rate In an extremely low interest rate environment, a note or bond auction could result in an interest rate lower than Treasury’s 1⁄8 of one percent interest rate increment. If that were to happen, under the current methodology the new security would be issued with a zero percent interest rate and would have no semi-annual interest payments. Treasury is amending the UOC because we believe it is preferable that Treasury notes and bonds pay regular, semi-annual interest payments.

III. Amendment to the Rule Accordingly, Treasury is amending paragraph (b) of 31 CFR 356.20 to state that if a Treasury note or bond auction results in a yield lower than 0.125 percent, the interest rate will be set at 1⁄8 of one percent with the price adjusted accordingly (i.e., at a premium). This change applies to all new marketable Treasury note and bond issues: Treasury fixed-principal 5 (also referred to as nominal) notes and bonds as well as Treasury inflation-protected notes and bonds. (emphasis added)
Good. That's a lot better than writing a check to the Guv'ment every six months when the negative coupon is due. :)
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Re: Why does the US issue TIPS?

Post by nisiprius »

Doc wrote:IIRC way back at the beginning there were two reasons for offering "Treasury Inflation Indexed Securities".
Thanks for the memories. Yes, when I first bought them, they were called "IINS" by the Treasury and listed that way on the statements.

I'm not quite sure when the change to "TIPS" took place or who was responsible for it (i.e. did the government change the name or did they simple accept a name bestowed on them by brokerages?) There was definitely a period of overlap, because I remember being confused as to whether or not "TIPS" were the same things as "IINS."
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Post by grok87 »

Valuethinker wrote:
grok87 wrote:
tetractys wrote:Anyone have any insight on whether or not TIPS carry an element of inflation control along with their issuance? -- Tet
I don't think at current levels of TIPs issuance. Because they are not a huge part of outstanding treasury debt. But i think the fact that us debt is fairly short term in duration does give the treasury an incentive to make sure inflation doesn't get out of hand...
cheers,
The argument not to fund far out along the curve is

1. higher cost to US taxpayer

2. US will return to fiscal prudence and repay debt, long debt will turn out to be expensive in that case

It's nonsense. UK has an average maturity of debt of 14 years, US around 5 I believe (along with most other developed nations).

If you are a high credit rating sovereign borrower you should borrow essentially forever, or at least as long as you can and the market demands.

US 30 and 40 year TIPS should show significant demand because of their hedging properties, and it's almost impossible to buy private sector debt 30 years + in any form (let alone inflation linked).

You reduce the risk of a liquidity/ rollover crunch by funding long.
Hmm... I can't quite work out if we agree or disagree. I agree with pretty much all of what you are saying and personally i think the US should issue more long term bonds.

But I guess what i am saying is this...

Let's take the investing element out of it and just consider say a retiree on a fixed pension (i.e. not inflation adjusted) who has no other investments.
THis retiree is clearly very exposed to inflation risk. What debt issuance policy of the US government would me most reassuring to that retiree from a managing inflation risk perspective:

a) all T-bills
b) all 30 year nominal treasuries
c) all 30 year TIPs

I would argue that retiree would be most reassured with regard to his inflation risk by either a) or c) as in either of those cases the government has a clear interest in managing inflation risk properly.

cheers,
RIP Mr. Bogle.
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Post by Valuethinker »

grok87 wrote:
But I guess what i am saying is this...

Let's take the investing element out of it and just consider say a retiree on a fixed pension (i.e. not inflation adjusted) who has no other investments.
THis retiree is clearly very exposed to inflation risk. What debt issuance policy of the US government would me most reassuring to that retiree from a managing inflation risk perspective:

a) all T-bills
b) all 30 year nominal treasuries
c) all 30 year TIPs

I would argue that retiree would be most reassured with regard to his inflation risk by either a) or c) as in either of those cases the government has a clear interest in managing inflation risk properly.

cheers,
I certainly agree with you.

But I wouldn't endow any government with such a sense of purpose over the long term. The US Treasury does not determine the inflation rate, it just looks for the lowest cost of funding.

My view is since we know markets go through ructions, the goal of any national treasury should be to fund long and to have a fairly even 'roll' of existing debt in any given fiscal year.

By issuing long term securities it also creates a private sector ability to hedge against liabilities (pension or insurance) and that creates a public good-- a net economic benefit.
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Post by grok87 »

Valuethinker wrote:
grok87 wrote:
But I guess what i am saying is this...

Let's take the investing element out of it and just consider say a retiree on a fixed pension (i.e. not inflation adjusted) who has no other investments.
THis retiree is clearly very exposed to inflation risk. What debt issuance policy of the US government would me most reassuring to that retiree from a managing inflation risk perspective:

a) all T-bills
b) all 30 year nominal treasuries
c) all 30 year TIPs

I would argue that retiree would be most reassured with regard to his inflation risk by either a) or c) as in either of those cases the government has a clear interest in managing inflation risk properly.

cheers,
I certainly agree with you.

But I wouldn't endow any government with such a sense of purpose over the long term. The US Treasury does not determine the inflation rate, it just looks for the lowest cost of funding.

My view is since we know markets go through ructions, the goal of any national treasury should be to fund long and to have a fairly even 'roll' of existing debt in any given fiscal year.

By issuing long term securities it also creates a private sector ability to hedge against liabilities (pension or insurance) and that creates a public good-- a net economic benefit.
It's sort of an interesting problem isn't it. Let me try out a hypothesis on you that runs slightly counter to your argument. Let's say the US treasury issues only the longest debt- say 30 year bonds- and does so every year so that they have a, as you put it fairly even roll of existing debt in every year. That could make bond investors nervous. They may say, hey the US government has no real incentive to try to control inflation here (while I agree with yout that inflation is not totally under the governments control but they do have SOME tools to try to control it such a fed funds rate, fiscal policy etc.) because it is nominal debt with a long average maturity. So as a consequence bond investors may demand more of an inflation risk premium on newly issued 30 year treasury bonds driving up their yield and the US treasury's cost. So I think there is an optimum maturity level of issuance. My own opinion is that it is probably longer than the current average maturity (4?) but shorter than 30 years (I guess it would really be 15 years wouldn't it, in steady state, if the US treasury only issued 30 year nominal debt and kept rolling it over). I'm guessing the best thing would maybe be an average maturity of about 7 years? (just made that number up, but has a nice old testament / Exodus resonance, 7 fat years and 7 lean years).
Anyway food for thought perhaps...
cheers,
RIP Mr. Bogle.
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Post by Doc »

grok87 wrote: It's sort of an interesting problem isn't it. Let me try out a hypothesis on you that runs slightly counter to your argument. Let's say the US treasury issues only the longest debt- say 30 year bonds- and does so every year so that they have a, as you put it fairly even roll of existing debt in every year. That could make bond investors nervous. They may say, hey the US government has no real incentive to try to control inflation here (while I agree with yout that inflation is not totally under the governments control but they do have SOME tools to try to control it such a fed funds rate, fiscal policy etc.) because it is nominal debt with a long average maturity.
There is the US Treasury and then there is the "independent" Federal Reserve and then there is the Constitution that has us elect our politicians every 2/4/6 years. The main purview of the Treasury is to fund the government. The purview of the Fed is to have a smoothly run banking system with secondary priorities on GDP growth, employment and inflation. No sense in guessing what the purview of the politicians is because it will change every 2/4/6 years. :roll:
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Post by Valuethinker »

grok87 wrote:
Valuethinker wrote:
grok87 wrote:
But I guess what i am saying is this...

Let's take the investing element out of it and just consider say a retiree on a fixed pension (i.e. not inflation adjusted) who has no other investments.
THis retiree is clearly very exposed to inflation risk. What debt issuance policy of the US government would me most reassuring to that retiree from a managing inflation risk perspective:

a) all T-bills
b) all 30 year nominal treasuries
c) all 30 year TIPs

I would argue that retiree would be most reassured with regard to his inflation risk by either a) or c) as in either of those cases the government has a clear interest in managing inflation risk properly.

cheers,
I certainly agree with you.

But I wouldn't endow any government with such a sense of purpose over the long term. The US Treasury does not determine the inflation rate, it just looks for the lowest cost of funding.

My view is since we know markets go through ructions, the goal of any national treasury should be to fund long and to have a fairly even 'roll' of existing debt in any given fiscal year.

By issuing long term securities it also creates a private sector ability to hedge against liabilities (pension or insurance) and that creates a public good-- a net economic benefit.
It's sort of an interesting problem isn't it. Let me try out a hypothesis on you that runs slightly counter to your argument. Let's say the US treasury issues only the longest debt- say 30 year bonds- and does so every year so that they have a, as you put it fairly even roll of existing debt in every year. That could make bond investors nervous. They may say, hey the US government has no real incentive to try to control inflation here (while I agree with yout that inflation is not totally under the governments control but they do have SOME tools to try to control it such a fed funds rate, fiscal policy etc.) because it is nominal debt with a long average maturity. So as a consequence bond investors may demand more of an inflation risk premium on newly issued 30 year treasury bonds driving up their yield and the US treasury's cost. So I think there is an optimum maturity level of issuance. My own opinion is that it is probably longer than the current average maturity (4?) but shorter than 30 years (I guess it would really be 15 years wouldn't it, in steady state, if the US treasury only issued 30 year nominal debt and kept rolling it over). I'm guessing the best thing would maybe be an average maturity of about 7 years? (just made that number up, but has a nice old testament / Exodus resonance, 7 fat years and 7 lean years).
Anyway food for thought perhaps...
cheers,
Assuming the yield curve flattens at the 7 year, or the 10, then you want an average maturity above that flattening point.

Since a 30 year bond (real return) doesn't cost much more than a 15 year bond for the US Treasury, it should go out as far as it can.

But you want a long term so that regardless of your annual funding needs (net issue of bonds) your gross issue of bonds is smoothed-- the 'roll' is smaller.

If 30 year bonds paid far far higher premia than 10 year bonds, then you should shorten your maturities. The market would do this to you, if it feared your resolve re inflation (lack of). Then it would be too expensive to borrow long.

On US Long TIPS right now 'the ducks are quacking. Feed 'em'.

The UK DMO was looking the odd man out pre credit crunch with such a long maturity schedule. Now they look rather shrewd against other national treasuries.

Note if your funding need (net) is volatile then you need to vary maturity schedules of debt to keep a roughly constant maturity.
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