Treasury Sells Inflation Notes at Record Low Negative Yield

Treasury Sells Inflation Notes at Record Low Negative Yield
The U.S. Department of the Treasury. Photographer: Andrew Harrer/Bloomberg

The U.S. sold $13 billion of 10-year inflation-indexed notes at a record negative yield with investors willing to pay a premium to guard against the threats of rising consumer prices and Europe’s worsening debt crisis.

The Treasury Inflation Protected Securities were sold at a so-called high yield of negative 0.391 percent, the third consecutive auction where investors paid the government to hold their money. TIPS pay interest at lower rates than regular Treasuries on a principal amount that’s adjusted based on the Labor Department’s consumer price index.

While yields on Treasuries due in 10 years or less are below the pace of inflation, demand is at record highs for U.S. government debt amid competition for a dwindling supply of the safest assets. The International Monetary Fund said last month that the amount of global assets that investors consider “safe” will shrink by $9 trillion by 2016.

“The demand for investors is very strong for both inflation protection and safety,” said Aaron Kohli, an interest-rate strategist at BNP Paribas SA in New York, one of the Federal Reserve’s 21 primary dealers that are required to bid at the auctions. “Cash still needs to be put to work, and investors are looking for any sort of value. TIPS offer that given the strong U.S. fundamentals relative to what else is out there, and all the richness in other safe assets.”

The bid-to-cover ratio for the notes, which gauges demand by comparing the amount bid with the amount offered, was 3.01, the strongest since April 2010, and higher than the average of

2.73 at the past 10 auction of the securities.

Consumer Prices

The U.S. cost of living was unchanged in April, restrained by a drop in energy prices and supporting the view of some Fed policy makers that inflation will ease.

Last month’s consumer price index matched the median forecast of economists surveyed by Bloomberg News and followed three straight gains that included a 0.3 percent rise in March, Labor Department data showed May 15. The so-called core measure, which excludes more volatile food and energy costs, rose 0.2 percent for a second month.

Slowing inflation is allowing the central bank to stick to its plan to keep interest rates low at least until late 2014.

At the same time inflation-adjusted yields have been under pressure as the Fed continues to extend the average maturity of its $2.89 trillion securities portfolio, a program dubbed by traders as Operation Twist, and maintains its policy of reinvesting maturing housing debt into agency mortgage-backed securities.

Fed’s Objective

“There is an underlying demand for longer dated inflation protection as there is still a question on if inflation can be contained when the Fed unwinds their massive stimulus,” said John Briggs, a bond strategist at primary dealer RBS Securities Inc. in Stamford, Connecticut.

“Negative yields are a reflection of the overall low level of rates and the Fed’s attempt to push people out of risk-free assets into products that offer a positive real return,” Briggs said.

Several Fed policy makers said a loss of momentum in growth or increased risks to their economic outlook could warrant additional action to keep the recovery on track, minutes of their last meeting released yesterday showed.

The difference between yields on U.S. 10-year notes and comparable TIPS, a gauge of expectations for inflation during the life of the debt known as the break-even rate, was 2.11 percentage points. The average during the past decade is 2.15 percentage points.

TIPS Returns

Indirect bidders, a category of investors that includes foreign central banks, bought 50.7 percent of the securities at the sale today, compared to an average of 40.31 percent at the past 10 auctions. Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 14.8 percent of the securities, versus an 11.36 percent average at the past 10 auctions.

U.S. inflation-linked debt maturing in 10 or more years has returned 5.1 percent this year, compared with a 1.1 percent gain in the overall Treasury market, Bank of America Merrill Lynch index data show.

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