Key takeaways from the Treasury Inflation Protected Securities (or TIPS) auction
Last week, the U.S. Treasury auctioned securities worth $95 billion. These included Treasury bills and Treasury Inflation Protected Securities (or TIPS).
When inflation rises, nominal bond (TLT) yields rise. As bond prices (BND) and yields move in opposite directions, this erodes the value of bonds. TIPS offer bond investors protection against rising inflation.
TIPS auctions are held each month by the U.S. Department of the Treasury. The principal of a TIPS is indexed to the Consumer Price Index (or CPI), which increases or decreases with inflation. On maturity, you would be paid the greater of the adjusted principal or the original principal amount of the TIPS. The coupon payments on TIPS are applied to the adjusted principal. Thus, the coupon payments on TIPS provide the bondholder with a fixed amount of purchasing power. Exchange-traded funds (or ETFs) providing exposure to TIPS include the iShares TIP Bond ETF (TIP).
Highlights from the 30-year TIPS auction
- The auction was held on October 23. TIPS worth $7 billion were auctioned, the same as the last auction held in June.
- The auction was a reopening of February’s auction. Consequently, the securities will mature in February 2044.
- The coupon rate for the securities was 1.375%, the same as February’s rate. The high yield came in at ~0.985% compared to February’s rate of 1.495%.
- The bid-cover ratio for the auction was ~2.3x.
Demand analysis: TIPS auction sees strong overseas bidding
The bid-to-cover ratio at 2.3x was the lowest since 2001. The bid-to-cover ratio is an important demand indicator. It’s computed as the value of bids made divided by the value of securities auctioned.
Despite the low bid-to-cover ratio, market demand for the securities rose. Market demand includes both direct and indirect bids. Indirect bidders, a category that includes foreign central banks, were strong bidders at the auction. The percentage of competitive accepted bids made by indirect bidders rose to 64.5%, the highest in the period since the auctions were resumed in February 2010.
Direct bids were lower, however, at 4.5% of the competitive bids, compared to 8.2% at June’s auction. These include bids made by domestic money managers (think the financial sector) (XLF) firms like Berkshire Hathaway (BRK-B). BRK-B is part of the SPDR S&P 500 ETF (SPY).
We’ll analyze the TIPS yields in greater detail in the next section.