A $16 billion auction of U.S. five-year inflation-indexed notes drew the highest yield in more than three years amid bets the economic recovery is strong enough for the Federal Reserve to begin withdrawing monetary stimulus.
The Treasury Inflation Protected Securities sold yesterday yielded negative 0.127 percent, the highest level since April 2010, with investors wary of paying a premium to guard against the threat of rising consumer prices. The last sale, an $18 billion offering on April 18, drew a yield of negative 1.311 percent, the second-lowest on record, after the securities sold at a record negative 1.496 percent in December 2012.
“The front end of the TIPS curve is not an area where people are super-excited about after the backup in rates we’ve seen,” said George Goncalves, the head of interest-rate strategy at Nomura Holdings Inc., one of the 21 primary dealers obligated to bid at U.S. debt auctions. “Investors are even less worried about inflation as we get closer to tapering, because there will be less money in the system.”
Holders of TIPS receive an adjustment to the principal value of their securities equal to the change in the consumer price index, in addition to a fixed rate of interest that’s smaller than the interest paid to a holder of conventional debt.
Yesterday’s sale had a 2.18 bid-to-cover ratio, a gauge of demand that compares the amount bid with the amount offered, matching the ratio at the previous auction in April, which was the weakest since October 2008. The average at the previous 10 sales was 2.77.
“There are still difficult times ahead for TIPS, as there is caution from investors in reengaging the market fully after the big selloff we’ve seen,” said Carlos Pro, an interest-rate strategist at the primary dealer Credit Suisse Group AG in New York. “There is a challenging outlook for inflation, with disinflation still a risk in the U.S. And that backdrop combines with the likely September taper from the Fed.”
TIPS maturing in three to five years have lost 3.6 percent this year, according to a Bank of America Merrill Lynch Indexes. TIPS of all maturities have slid 9.4 percent in 2013, on pace for the worst loss since they were first sold in 1997. The broader Treasury market has fallen 3.8 percent, Merrill Lynch data show.
Inflation expectations have plummeted this year as investors begin to price in an end to the Fed’s $85 billion monthly bond-buying program that has swelled the Fed’s balance sheet to a record $3.65 trillion.
Minutes of the Federal Open Market Committee’s last policy meeting, released on Aug. 21, showed officials are comfortable with a plan to start reducing bond buying later this year if the economy improves.
The central bank will start tapering in September and end purchases in mid-2014, according to the median estimate in a Bloomberg survey of 48 economists conducted Aug. 9-13.
The FOMC holds its next meeting on Sept. 17-18.
The difference in yield between five-year notes and similar-maturity TIPS, a measure of trader expectations for inflation over the life of the debt, called the break-even rate, has fallen to 1.76 percentage points, down from a high for the year of 2.42 percentage points in March. The measure has averaged 2.07 percent over the past year.
The U.S. consumer-price index increased 0.2 percent in July after a 0.5 percent gain in June, the Labor Department reported Aug. 15. The advance matched the median forecast of 82 economists surveyed by Bloomberg.
At yesterday’s auction, indirect bidders, a class of investors that includes foreign central banks, purchased 38.2 percent of the TIPS. The average for the previous 10 offerings was 41.1 percent.
Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, bought 8.1 percent of the securities. The average at the past 10 sales was 8.9 percent.
Investors bid $2.89 for each dollar of the $1.345 trillion in U.S. government notes and bonds sold at auction this year, according to Treasury data compiled by Bloomberg. That’s down from the record $3.15 for the $2.153 trillion sold at last year’s offerings.