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Why Fundamental Demand Barely Moved 10-Year TIPS Auction

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May. 24 2016, Published 12:19 p.m. ET

10-year TIPS auction

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 increases with inflation and decreases with disinflation.

The U.S. Treasury auctioned ten-year TIPS worth $11 billion on May 19, 2016. The auction amount was set at $13 billion. The overall demand for the securities rose by 0.9% from the previous auction, with a bid-to-cover ratio of 2.3x. The ratio depicts overall demand for the auction.

The fundamental demand, which depicts demand from a domestic and foreign investor, barely moved compared to the previous auction. That’s because investors were less interested in long-term securities when interest rates are expected to rise.

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PCE price index

The PCE (personal consumption expenditure) price index is the Federal Reserve’s preferred measure of inflation. That’s because it covers the broadest set of goods and services. The Fed is mandated by Congress to maintain the level of PCE inflation at 2% in the long term. In April, CPI rose just 1.1% in the past 12 months, up from 0.9% in March.

It’s expected that inflation will move closer to the Fed’s target by the end of the year due to higher oil (XOM) (WMB) (COP) prices, which will lead to an increase in prices of goods.

In early April, John Williams, president of the Federal Reserve Bank of San Francisco, and Dennis Lockhart, president of the Atlanta Federal Reserve Bank, said that with improvement in the job market, inflation could soon hit the Fed’s target. That would make a stronger case for a rate hike. This could lead to investments in short-term TIPS.

Investment impact

With the probability of a rate hike getting stronger and the rise in inflation, some investors think it’s wise to invest in short-term TIPS such as the Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) and the PIMCO 1-5 Year U.S. TIPS Index ETF (STPZ). For the week ended May 20, 2016, VTIP and STPZ fell 0.2% and 0.5%, respectively.

In the next part, we’ll see when some fund managers are expecting a rate hike.

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