How TIPS help
Bond yields rise due to higher inflation expectations. TIPS (Treasury Inflation-Protected Securities) are instruments that 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 increases with inflation, and vice-versa.
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. Hence, the coupon payments on TIPS provide an investor with a fixed amount of purchasing power. Mutual funds that provide exposure to TIPS include the Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX) and the Fidelity Inflation-Protected Bond Fund (FINPX).
30-Year TIPS auction on February 18
The US Treasury auctioned 30-Year TIPS worth $7 billion on February 18, 2016. The amount was the same as during the October 22, 2015, auction. The overall demand for securities tanked by 19.5%, with a bid-to-cover ratio of 2.1x—the lowest in recent times and lower than the October auction’s 2.6x.
The high discount rate came in at 1.1%. It was lower than the 1.2% reported in October’s auction.
Market demand fell
Total market demand fell compared to the October auction. Direct bids tanked from 8.5% in October to 2.8% of the total competitive accepted bids in February. Direct bids include bids from domestic money managers such as Wells Fargo (WFC) and State Street (STT). Indirect bids include bids from foreign governments. They nudged up from 69.8% in October 2015 to 70.3% in February 2016.
Due to low market demand, primary dealer uptake rose from 21.7% in October to 26.9% in February. An increase in primary dealer bids implies lower underlying market demand. Primary dealers are a group of 22 authorized broker-dealers. They’re required to bid at US Treasury auctions. They include companies such as JPMorgan Chase (JPM) and Goldman Sachs (GS).
From the next articles onward, we’ll look at Treasury bill auctions that took place last week.