Help me understand current I-Bond and TIPS yields

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danielc
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Help me understand current I-Bond and TIPS yields

Post by danielc »

Let's see... current CPI is about 2.6%, and the composite rate for I bonds issued from May 2021 through October 2021 is 3.54%. So that works out to a real interest rate of 0.96% right now.

So far so good?

Where I'm getting confused is that I would expect TIPS to have a similar real interest rate, but the TreasuryDirect page says that the interest rate on TIPS is 0.125%. I assume that that must be the real interest rate. Shouldn't that value be a lot closer to the 0.96% from I-Bonds? Worse yet, the page for iShares STIP which holds 0-5 year TIPS reports a 30-day SEC yield of 6.47%, a YTM of 1.48%, and a real return of -2.30% and so I feel that nothing makes any sense.

Can someone help me understand what's going on?
  • If I were to buy an I-Bond today, what real yield should I expect?
  • If I were to buy a 5-year TIPS today, what real yield should I expect?
  • If I were to put buy the iShares STIP ETF today, what real yield should I expect?
I would really appreciate some help. Thanks!
Walkure
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Re: Help me understand current I-Bond and TIPS yields

Post by Walkure »

danielc wrote: Tue May 11, 2021 5:34 pm
  • If I were to buy an I-Bond today, what real yield should I expect?
  • If I were to buy a 5-year TIPS today, what real yield should I expect?
  • If I were to put buy the iShares STIP ETF today, what real yield should I expect?
I would really appreciate some help. Thanks!
If you buy an I-bond today, and held to maturity, you should expect a real yield of 0% before taxes, because that is the fixed rate. Any temporary dislocations resulting from the composite rate lagging real-time inflation by up to 6 months will average out over time. I-bonds are a unique creature that are only available to retail investors in limited amounts, and under current rules cannot go negative.

TIPS on the other hand have a negative expected real yield at this time and are marketable securities. I have no idea what is causing the SEC yield to come out differently.
alluringreality
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Re: Help me understand current I-Bond and TIPS yields

Post by alluringreality »

danielc wrote: Tue May 11, 2021 5:34 pmIf I were to buy an I-Bond today, what real yield should I expect?
The current I bond fixed rate is 0%. While it may be possible to have some differences between current inflation and the trailing inflation used for payment, personally I anticipate real return based on the fixed rate before paying taxes. Since it's necessary to stay invested for at least a year, and pay a 3 month penalty before 5 years, plus the yearly limit on purchases, what you're looking at simply goes into an insignificant category for me.
danielc wrote: Tue May 11, 2021 5:34 pm the TreasuryDirect page says that the interest rate on TIPS is 0.125%. I assume that that must be the real interest rate.
I'm less familiar with TIPS, but that minimum rate is not a real interest rate. The real rate for 5 year TIPS is negative at this time. The negative rate relates to the price paid when TIPS are purchased. I think the following might be where it's explained.
https://www.treasurydirect.gov/indiv/re ... _rates.htm
Targets: 15% I Bonds, 15% EE Bonds, 45% US Stock (Mid & Small Tilt), 25% Ex-US Stock (Small Tilt)
David Althaus
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Re: Help me understand current I-Bond and TIPS yields

Post by David Althaus »

I am always mystified by TIPS. Every day there are threads here on this. So, I can't figure whether there's now blood in the streets or market euphoria on them. They do seem to be very popular now--a danger sign? If I were younger I would refinance my house at these incredibly low rates and pay it back in the years ahead with ever cheaper dollars.

All the best
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Re: Help me understand current I-Bond and TIPS yields

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danielc wrote: Tue May 11, 2021 5:34 pm... current CPI is about 2.6%, and the composite rate for I bonds issued from May 2021 through October 2021 is 3.54%. So that works out to a real interest rate of 0.96% right now.
2.6% is the increase in the CPI over the 12 months March 2020 to March 2021. 3.54% is the composite rate that results from combining a 0% fixed rate with the 1.77% increase in the CPI over the 6 months September 2020 to March 2021. To see the effect of the 2.6% 12 month CPI change, [1] you should be looking at the 2.64% entire first year's growth of a 0% fixed rate I Bond purchased November 2020 to April 2021. [2]

danielc in same post wrote:the TreasuryDirect page says that the interest rate on TIPS is 0.125%. I assume that that must be the real interest rate.
Yes, that happens to be the interest rate (aka coupon) for the last six TIPS issued since April 2020. (See the 2nd column at the bottom of this webpage.) But it's the real yield, not the coupon, that should be compared to the 0% fixed rate of currently issued I Bonds. As of yesterday's close, according to WSJ TIPS Quotes this is negative for all TIPS. For instance the real yield of the most recently issued TIPS, the 5-year maturing April 2026, was -1.918%. [3]

danielc in same post wrote:... the page for iShares STIP which holds 0-5 year TIPS reports a 30-day SEC yield of 6.47%, a YTM of 1.48%, and a real return of -2.30%
Unfortunately fund managers report yields of their TIPS funds in different ways. [4] That's why I started the thread Consistent Yield & Duration to Help Choose TIPS Fund in 2012. It reports the weighted average yields-to-maturity for five TIPS indexes: 0-5, 1-5, 1-10, 1+, and 15+. I've recently started updating these yields weekly. For example as shown in this post, as of Friday 5/7/2021 the average yield (weighted by market value) of the TIPS in the "0-5" index (all TIPS maturing in less than five years) was -2.72%

  1. Here are the two 6-month increases and the overall 12 month increase:

    Code: Select all

                       - Increase -
               CPI-U   6 mo   12 mo
              -------  -----  -----
    Mar 2020  258.115
    Sep 2020  260.280  0.84%
    Mar 2021  264.877  1.77%  2.62%
  2. These I Bond values after one year ignore the 3-month penalty for redemption before 5 years.
  3. A negative yield on a bond can occur if the price is higher than the principal one receives at maturity. Here's a simple hypothetical case to illustrate this. Assume I can buy a $1,000 TIPS with a 1/8% annual coupon that matures in one year. At that time I will receive $1,000 principal plus $1.25 interest in constant dollars. If the price of that bond today is $1,020.83, I will get a negative 1.918% real return (before indexing to inflation).
    1,001.25 = 1020.83 * (1 - 1.918%)
  4. Some fund companies, like Vanguard, report a 30-day SEC yield based on the real yield of the fund's holdings. Others report a "nominal" SEC yield that attempts to include the effect of inflation. And some fund companies report it both ways. The best way, in my opinion, is to report a real yield. But even this isn't very useful if it is based on the average yield over the past 30 days. We wouldn't be satisfied if gas stations posted their average price over the past 30 days. What buyers of bonds as well as gasoline need to know is the yield (or price) now.
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Re: Help me understand current I-Bond and TIPS yields

Post by danielc »

#Cruncher wrote: Wed May 12, 2021 6:48 am 2.6% is the increase in the CPI over the 12 months March 2020 to March 2021. 3.54% is the composite rate that results from combining a 0% fixed rate with the 1.77% increase in the CPI over the 6 months September 2020 to March 2021. To see the effect of the 2.6% 12 month CPI change, [1] you should be looking at the 2.64% entire first year's growth of a 0% fixed rate I Bond purchased November 2020 to April 2021. [2]
Thanks!

#Cruncher wrote: Wed May 12, 2021 6:48 am Yes, that happens to be the interest rate (aka coupon) for the last six TIPS issued since April 2020. (See the 2nd column at the bottom of this webpage.) But it's the real yield, not the coupon, that should be compared to the 0% fixed rate of currently issued I Bonds. As of yesterday's close, according to WSJ TIPS Quotes this is negative for all TIPS. For instance the real yield of the most recently issued TIPS, the 5-year maturing April 2026, was -1.918%. [3]

...
  1. ...
  2. ...
  3. A negative yield on a bond can occur if the price is higher than the principal one receives at maturity. Here's a simple hypothetical case to illustrate this. Assume I can buy a $1,000 TIPS with a 1/8% annual coupon that matures in one year. At that time I will receive $1,000 principal plus $1.25 interest in constant dollars. If the price of that bond today is $1,020.83, I will get a negative 1.918% real return (before indexing to inflation).
    1,001.25 = 1020.83 * (1 - 1.918%)
So it sounds to me like the only reason why the real yield is negative in this example is because the secondary market has adjusted the price of the TIPS so it comes out similar to the negative real yield of other comparable bonds in the market. Am I right to say that if I had managed to pay $1,000 for a TIPS with a $1,000 principal then the coupon would equal the real yield? If I had gotten the TIPS at issue, I would have paid $1,000 for a $1,000 principal? If the answer is "no", does that mean that right now I-Bonds are a much better deal than TIPS (ignoring the 1-year wait and 3-month penalty) because with an I-Bond you always pay exactly $1,000 for a $1,000 principal? (I'm also assuming that the fact that TIPS adjust CPI more often is not relevant; but that might be a bad assumption).

#Cruncher wrote: Wed May 12, 2021 6:48 am Unfortunately fund managers report yields of their TIPS funds in different ways. [4] That's why I started the thread Consistent Yield & Duration to Help Choose TIPS Fund in 2012. It reports the weighted average yields-to-maturity for five TIPS indexes: 0-5, 1-5, 1-10, 1+, and 15+. I've recently started updating these yields weekly. For example as shown in this post, as of Friday 5/7/2021 the average yield (weighted by market value) of the TIPS in the "0-5" index (all TIPS maturing in less than five years) was -2.72%
Thanks! I'll go read that.
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Re: Help me understand current I-Bond and TIPS yields

Post by #Cruncher »

danielc wrote: Wed May 12, 2021 10:39 am
#Cruncher wrote: Wed May 12, 2021 6:48 am... For instance the real yield of the most recently issued TIPS, the 5-year maturing April 2026, was -1.918% [as of Tuesday's secondary market close]. ...
So it sounds to me like the only reason why the real yield is negative in this example is because the secondary market has adjusted the price of the TIPS so it comes out similar to the negative real yield of other comparable bonds in the market.
Market conditions obtain in a TIPS auction just as much as in the secondary market. For instance, the winning yield bid at the April 22nd auction of the 1/8% 5-year TIPS maturing 4/15/2026 was -1.631%. This was in line with the TIPS yield curve existing at that time in the secondary market. To produce this large negative yield, the issue was priced at 109.108% of par (before applying the inflation index).

danielc, continuing in same post, wrote:Am I right to say that if I had managed to pay $1,000 for a TIPS with a $1,000 principal then the coupon would equal the real yield? If I had gotten the TIPS at issue, I would have paid $1,000 for a $1,000 principal?
The answer is "yes" to the first sentence, but "no" to the second. If the price of a bond is close to par (e.g., $1,000 for $1,000 of principal), then the yield will be close to the coupon. For example, look at the 4/19/2018 auction of the 5/8% 5-year TIPS maturing 4/15/2023. The winning yield was +0.631%, close to the 0.625% coupon, resulting in a close-to-par price of 99.971%. But the re-auction of the same TIPS eight months later on 12/20/2018 had a winning yield of +1.129%, requiring a discounted price of 97.895%. [1]

However, that was 2018 when TIPS yields were higher and this is 2021 with negative yields on all but the longest maturity TIPS. Since Treasury notes and bonds have a minimum 1/8% coupon, there is no way you can buy at par when the yield is less than 0.125%. The only way for a bond with a positive coupon to have a negative yield is for the price to be above par.

danielc, continuing in same post, wrote:If the answer is "no", does that mean that right now I-Bonds are a much better deal than TIPS ... because with an I-Bond you always pay exactly $1,000 for a $1,000 principal? (I'm also assuming that the fact that TIPS adjust CPI more often is not relevant; but that might be a bad assumption).
At current TIPS yields an I Bond with a 0% fixed rate is a much better buy than any TIPS -- even very long term ones if they are to be held in a taxable account. As you say, you will always pay $1,000 for each $1,000 of principal. The timing of the CPI adjustment should average out over time. The two big disadvantages of I Bonds are that you can only buy $10,000 of them per person per year, [2] and you can't hold them in an IRA. [3]

  1. Both the yield and coupon are determined at the first auction of a Treasury note or bond. But at re-auctions only the yield is determined. So at such auctions, even if the coupon is higher than 0.125%, if the yield has gone down from what it was as the first auction, the price will be above par. For example at the 10/26/2009 re-auction of the 1-1/4% 5-year TIPS maturing 4/15/2014 the +0.769% yield was well below the +1.278% at the first auction. The price was therefore above par at 102.104%.
  2. This is for electronic I Bonds purchased at TreasuryDirect. You can also get up to $5,000 of paper I Bonds as part of a federal income tax refund.
  3. I Bonds do offer tax deferral, but this is not as good as the tax treatment one gets with either a traditional or Roth IRA.
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