TIPS yield 2.5% ?!

[lazyday]

I've never bought a bond before, so maybe just don't understand.

Am considering buying a short to intermediate TIPS in a traditional IRA, or if commissions are too high, use VIPSX instead even though it's of higher duration than I like, and has an ER.

Got a quote for CUSIP 9128272M3, which I believe is a TIPS maturing 1/15/07 (nice short duration) and at the buy price (not the sell) it seems to yield to maturity over 2.48!!

Wow! An inverted TIPS yield curve!

With that nice yield, compared to about 2% with VIPSX, is worth the commission to me.
Unless this bond newbie is just not understanding things

 

[LOL!]

Yield to maturity of 2.48%? Since savings accounts are now paying 4.25% and T-bills are in the same range, I'm not sure what's so special about 2.5%, except that it's pretty low.

 

[lazyday]

Real yield.

I haven't studied the mechanics of inflation adjustment, to see if that's the reason there seems to be an inverted real yield curve, from the quotes I see.

In other words, if the inflation adjustment happens in wierd ways as opposed to daily, then a bond maturing quickly might need a different treatment (for valuing it) than a very long bond.

 

[justin]

I had noticed the yield on the VG TIPS fund has been steadily creeping up for the last year or so. Last I saw it was at 2.00% (net of expenses), but 2.5%, wow!! I may have to consider this sector more strongly if it keeps going up.

 

[lazyday]

I think it's too good to be true tho. Maybe has something to do with size/timing of upcoming interest payment, and how that figures into (or doesn't) the ytm? Maybe a bond guru will post.

Started to look at the treasury website, and it's a bit to get through: http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_rates.htm

 

[Gone4Good]

Seems high to me. I've been watching the 2010 and its around 2.12% right now. Don't know why the '07 would offer an extra 36bp but it could be an anomaly.

 

[Gone4Good]

Seems high to me.  I've been watching the 2010 and its around 2.12% right now.  Don't know why the '07 would offer an extra 36bp but it could be an anomaly. 

Nope, I'm wrong.

The real yield curve is inverted and the yield on the '07s you quoted is in line with what Bloomberg tells me.

 

[lazyday]

So, can a bond guru here confirm, should I believe that the 2.5% ytm on a 1 year TIPS is comparable (in an apples to apples kind of way) to a 2.1% yield on a long term TIPS?
Or, is there some "catch" because of the bond maturing so soon, that it "should" have a higher reported ytm, because of the vagaries of the inflation adjustment or the interest payments, or some other reason?

My decision is between:
- buying a 1 year TIPS, paying commission and/or spread, and getting the short duration I want, and seemingly a higher yield, or
- buying Vanguard TIPS fund VIPSX.

 

[lazyday]

Yield to maturity is now just over 2.6%

That's at the offer price (bid shows about 2.7%), before commissions.

 

[wabmester]

Good find, lazyday. I bought some.

My guess is that the yield is abnormally high due to *deflation* fears. Yeah, I know that sounds crazy, but hear me out.

When you buy a new TIPS issue, you are guaranteed to get your original principal back even if there is net deflation. You don't get the same guarantee when you buy on the secondary market since you're paying for the accrued inflation adjustment upfront.

Recently, we had a spike in inflation. The market is apparently betting that inflation goes down in the next 12 months (probably a good bet), so that means that the 1/15/2007 TIPS has a good chance of a principal reduction from the current inflation-adjusted level.

I have no idea how to price that deflation factor into this bond, but I'll take my chances with the 1-year 7% nominal yield.

 

[nfs]

I have no idea how to price that deflation factor into this bond, but I'll take my chances with the 1-year 7% nominal yield.

Ummmm.....

If the YTM is 2.5% and published CPI over the next 12.5 months is zero, your nominal yield is going to be 2.5%, not 7%.

There's already a published figure of -0.8% for November 2005, which isn't yet in the TIPS adjustment factor because it runs a few months behind. The November CPI will start to kick in next month and the adjustment factor will reduce the nominal value of every TIPS issue by 0.8% in January, assuming everything else remains the same.

 

[wabmester]

If the YTM is 2.5% and published CPI over the next 12.5 months is zero, your nominal yield is going to be 2.5%, not 7%.

That's true, of course.   I was just extrapolating recent inflation as my guess for next year.    It could be zero, or even negative just as easily.

There's already a published figure of -0.8% for November 2005, which isn't yet in the TIPS adjustment factor because it runs a few months behind.  The November CPI will start to kick in next month and the adjustment factor will reduce the nominal value of every TIPS issue by 0.8% in January, assuming everything else remains the same.

Right, and that partly explains the real yield premium.    November deflation will be factored into the January inflation adjustment.

Here's the January index ratio table based on Nov CPI:

http://www.publicdebt.treas.gov/of/of10a012006.htm

I've also noticed that December is very often a deflationary month (zero or negative every year since 1992):

[ftp]ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt[/ftp]

 

[Gone4Good]

So, can a bond guru here confirm, should I believe that the 2.5% ytm on a 1 year TIPS is comparable (in an apples to apples kind of way) to a 2.1% yield on a long term TIPS?
Or, is there some "catch" because of the bond maturing so soon, that it "should" have a higher reported ytm, because of the vagaries of the inflation adjustment or the interest payments, or some other reason?

My decision is between:
- buying a 1 year TIPS, paying commission and/or spread, and getting the short duration I want, and seemingly a higher yield, or
- buying Vanguard TIPS fund VIPSX.

Yes. The 1 year TIPS real yield is comparable to longer dated TIPS. And yes, it appears as if the real yield is inverted, not just for the 1 year security but for the 5, 10 and 20 year securities as well. The only "catch" is that the higher yield is only good for 1 year.

My guess as to why the real yield curve is inverted has to do with inflation expectations and the "flatness" of the treasury curve. The difference between the treasury curve and the TIPS curve is the market's expectation of future CPI plus a risk premium. With energy prices declining the next few readings of the CPI will probably be fairly low, so near-term inflation (CPI) expectations are also low. Considering that short treasury rates are around 4%, a low expected CPI over the next few months results in a higher "real yield" (Treasuries of 4% - expected CPI = 2.5%). Over the longer-term CPI expectations are higher than the 1.5% imbedded in the 1-year TIPS. Because of the flat treasury curve, these higher future CPI expectations come out of the "real yield" resulting in real yield inversion.

 

[MooreBonds]

Ummmm.....

If the YTM is 2.5% and published CPI over the next 12.5 months is zero, your nominal yield is going to be 2.5%, not 7%.

There's already a published figure of -0.8% for November 2005, which isn't yet in the TIPS adjustment factor because it runs a few months behind. The November CPI will start to kick in next month and the adjustment factor will reduce the nominal value of every TIPS issue by 0.8% in January, assuming everything else remains the same.

I'm eagerly awaiting May 1, when the Treasury will release the new I-bond fixed rate. Because of the above deflation factors, I think the overall net CPI between Nov 1 2005 and May 1 2006 will net out to be very low...and, if short-term interest rates are still in the 4%+ range, it might force the Treasury to jack up the fixed portion of the I-bond so the overall (Fixed + CPI) to be 'comparable' to the current short-term rates.

However, as many have pointed out, just how the Treasury selects the fixed I-Bond rate is anyone's guess.

I know I'll keep a few thousand $ handy to take advantage of any I-bond jumps to add to my stash on May 1...

--Peter

 

[lazyday]

Thanks for all the responses.

(my italics below)

There's already a published figure of -0.8% for November 2005, which isn't yet in the TIPS adjustment factor because it runs a few months behind.

November deflation will be factored into the January inflation adjustment.

So, when we see the YTM of a TIPS at a brokerage website, do you think it is using a stale principal amount? (If it is using the current official principal, which is stale?)

Today, Dec 27, the reference CPI is 199.13548. If that is based on numbers from a few months ago, and over the last few months inflation was unusually low, then the bond would look cheaper than it really is!

If we can predict the future reference CPI numbers (which are acutally used to determine the principal value of the bond, I think) based on recent data, we might be able to guess a YTM for the bond, using current data.
For example, http://www.publicdebt.treas.gov/of/of10a012006.htm
shows that the 1/31/06 reference CPI will be 197.65161. If that were using the most recent inflation data available (I doubt that), and data more recent couldn't be guessed (also unrealistic), then we could calculate a guess of the "true" YTM using today's estimated current principal value, which might be something like 1.8%, based on a simple approx of (1.026)(197.65161-199.13548)/199.13548 - 1.

Am I on the right track? It could help to know how stale the current reference CPI numbers are, and if the "current" reference CPI number is actually being used to calculate YTM on a brokerage site. Also, the most recent CPI data.

Maybe I should just buy SHY or VFSTX instead. [smiley tearing hair out]

 

[wabmester]

Am I on the right track?

No.

The CPI-U numbers come out once a month, but the TIPS inflation adjustment is done daily based on the published tables referenced eariler.

If you buy this bond, you're making a bet on short-term inflation. The market is essentially telling you that predicted inflation is around 2% for the 12 months starting 10/2005, and deflation in November is already factored in, so you'll need something like a 2.8% increase in the CPI from now till maturity to break even (vs nominal treasuries).

I kind of like this bond because it's a little more exciting than a 1-year CD, and I think core inflation is heating up. But I'm not sure why you'd consider it for your IRA (which I assume is long-term).

 

[lazyday]

But I'm not sure why you'd consider it for your IRA (which I assume is long-term).

I want short duration because I consider interest rate risk to be more important to me than reinvestment risk today, and I don't find long rates vs short to adequately compensate for interest rate risk. Even with TIPS.

Why put it in the IRA? I'm slowly trying to get my taxable accounts to be 100% foreign equity indexes (plus 1yr spending money) so I can collect the foreign tax credit.
So, rather than hold more cash/STbonds than I need to in taxable, I'm holding some in IRA. The traditional IRA, since I'll have to pay taxes when take the money out, and I expect cash/STbonds to underperform equity in long run.

Also, cash/STbonds income is taxable at the income rate, so if I held it in taxable, would have to pay that each year, instead of deferring equity cap gains to future, and for now at least, paying a lower tax rate compared to bond income.

If I need the money, I can always sell some equity in taxable, and use some of the cash in IRA to buy equity.

 

[BUM]

VIPSX down 2.7% today. What should we drink?

 

[wabmester]

VIPSX down 2.7% today.    What should we drink?

Drink dividends. Your fund made a distribution today (payable tomorrow).

 

[BUM]

Drink dividends. Your fund made a distribution today (payable tomorrow).

HNY Wab.

Ummmmmmmm dividends. I just didnt expect that much of a drop in price. Last year dividend was about 20 cents...not complaining really. Maybe time buy more since I bought in January at 12.50