What are TIPS?
Nominal bond yields rise due to higher inflation expectations. Treasury inflation-protected securities (or TIPS) protect the value of debt securities from eroding due to inflation. A TIPS principal is indexed to the Consumer Price Index (or CPI). The TIPS principal rises with inflation and falls with disinflation.
On maturity, an investor is paid the greater of the adjusted principal or the TIPS original principal amount. The coupon payments on TIPS are applied to the adjusted principal. As a result, the coupon payments on TIPS provide the bondholder with a fixed amount of purchasing power.
Key takeaways of 10-year TIPS auction
The US Treasury auctioned 10-year TIPS worth $15 billion on January 21, 2016. The amount was $2 billion higher than it was in the November 19, 2015, auction. The overall demand for securities fell by 8.0% from the previous auction, with the bid-to-cover ratio at 2.2x on January 21. The coupon rate was higher at 0.63% compared to 0.38% in the previous auction.
The high yield came in at 0.73%, higher than the 0.66% reported in November’s auction. This rate is the highest in recent times.
Market demand fell
Market demand fell as compared to the November auction. Direct bids rose from 7.5% of total competitive accepted bids in November to 9.9% in January. Direct bids include bids from domestic money managers such as Invesco (IVZ) and BlackRock (BLK). Indirect bids include bids from foreign governments. They fell from 67.2% in November to 56.6% in January.
Due to lower market demand, primary dealers’ uptake rose from 25.3% in November to 33.6% in January. Primary dealers are a group of 22 authorized broker-dealers. They are required to bid at US Treasury auctions. They include companies such as Credit Suisse (CS), Morgan Stanley (MS), and Nomura Holdings (NMR).
Investors can take exposure to TIPS through investing in mutual funds.
The Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX) invests ~31% of its assets in TIPS, with maturities in the range of seven to ten years. The fund’s week-over-week return fell 0.16%.
Similarly, the Fidelity Inflation-Protected Bond Fund (FINPX) invests ~26% of its assets in TIPS, with maturities in the range of seven to ten years. The fund’s weekly return fell 0.25%.
From the next articles onward, we’ll look at the Treasury bill auctions that took place last week.