Meaning and importance of TIPS
Nominal bond yields rise due to higher inflation expectations. TIPS (Treasury Inflation-Protected Securities) protect the value of debt securities from eroding due to inflation. A TIPS principal is indexed to the CPI (consumer price index). The TIPS principal increases with inflation and decreases 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. Funds such as the Vanguard Inflation-Protected Securities Fund – Investor Shares (VIPSX), the iShares TIPS Bond ETF (TIP), and the PIMCO 1-5 Year U.S. TIPS Index ETF (STPZ) provide exposure to five-year TIPS securities.
Key takeaways of five-year TIPS auction
The US Treasury auctioned five-year TIPS worth $14 billion on August 18. The overall demand for the securities, as measured by the bid-to-cover ratio, fell 2.1% from the previous auction to 2.4x in August auction. The coupon rate came in at 0.13%.
The high yield came in negative for the second consecutive auction. The high yield for the August auction came in at -0.21%.
Market demand rose slightly
Market demand rose slightly from the previous auction. Direct bids, which include bids from domestic money managers such as Invesco (IVZ) and BlackRock (BLK), fell. Indirect bids, bids from foreign governments, rose.
Due to slightly higher market demand, primary dealers’ uptake fell. Primary dealers are a group of 22 authorized broker-dealers. They’re required to bid at US Treasury auctions. They include firms like Credit Suisse (CS), Morgan Stanley (MS), and Nomura Holdings (NMR).