Trading Treasuries (nominal and TIPS)

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MisterMister
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Re: Trading Treasuries (nominal and TIPS)

Post by MisterMister »

Kevin M wrote: Wed Aug 10, 2022 5:03 pm
MisterMister wrote: Wed Aug 10, 2022 4:46 pm
Kevin M wrote: Wed Aug 10, 2022 4:32 pm The yield for the shorter-term TIPS bought last week are higher this week, so there is even more incentive to hold TIPS bought at lower yields--at least that's the way I see it.
I must confess I can't wrap my head around this part of your response. I bought some of the 1/15/23 TIPs at yields as low as -2% a few weeks back. At that moment, my purchase said in effect that I would have to be satisfied with a -2% real yield, no matter what the future holds for the CPI over the next 3 months. Because that's all I will ever see in the end, regardless of where yields move for the same security before January 15.

I understand why you might want to add to the position at a lower price point. Just trying to undestand what bearing current higher yields have on the perceived value of an earlier trade and whether or not it should be held to maturity.
I make investment decisions on forward-looking expected return. The expected return for the TIPS I bought at lower yields is higher now than when I bought them. So if I found them attractive at lower yields, they are even more attractive now, whether I'm holding or buying more.

The lowest yield I got was -3.36% (SA -3.81%) for 07/01/2022 settlement. So yeah, I will earn -3.36% real from the purchase date to maturity, but I will earn 0.08% real on them from now to maturity. And if I sold them now, my return would be -0.51% nominal and -2.03% real. So basically I've already taken the hit for the negative real yield at purchase, and I might as well hold to maturity to get the remaining positive real yield from now until maturity.

Kevin
Thanks, this is helpful.
silvergga
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Re: Trading Treasuries (nominal and TIPS)

Post by silvergga »

Considering the 01/15/2024 TIPS (~1.5 years from now), with Ask to maturity yield of 0.379.

I read before that depending on the TIPS interest crediting time, the yield for shorter term tips would be thrown off?

Would that be the case for the 01/15/2024 maturing TIPS?
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

silvergga wrote: Thu Aug 11, 2022 1:01 am Considering the 01/15/2024 TIPS (~1.5 years from now), with Ask to maturity yield of 0.379.

I read before that depending on the TIPS interest crediting time, the yield for shorter term tips would be thrown off?

Would that be the case for the 01/15/2024 maturing TIPS?
I don't know what you mean by "TIPS interest crediting time", but there is a seasonality effect that causes weird shapes in the yield curve. By adjusting for the seasonality, the yield curve is smoothed out to more what we'd expect. For an ask yield of 0.39% for the 1/15/2024 TIPS (quote from Fidelity today), the seasonally adjusted yield is 0.12%.

Kevin
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silvergga
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Re: Trading Treasuries (nominal and TIPS)

Post by silvergga »

Kevin M wrote: Thu Aug 11, 2022 2:55 am
silvergga wrote: Thu Aug 11, 2022 1:01 am Considering the 01/15/2024 TIPS (~1.5 years from now), with Ask to maturity yield of 0.379.

I read before that depending on the TIPS interest crediting time, the yield for shorter term tips would be thrown off?

Would that be the case for the 01/15/2024 maturing TIPS?
I don't know what you mean by "TIPS interest crediting time", but there is a seasonality effect that causes weird shapes in the yield curve. By adjusting for the seasonality, the yield curve is smoothed out to more what we'd expect. For an ask yield of 0.39% for the 1/15/2024 TIPS (quote from Fidelity today), the seasonally adjusted yield is 0.12%.

Kevin
Thanks Kevin. How is the seasonal adjusted yield calculated?

Also, does the seasonal adjustment affect the shorter term TIPS more than longer term TIPS?
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

silvergga wrote: Thu Aug 11, 2022 12:40 pm
Kevin M wrote: Thu Aug 11, 2022 2:55 am
silvergga wrote: Thu Aug 11, 2022 1:01 am Considering the 01/15/2024 TIPS (~1.5 years from now), with Ask to maturity yield of 0.379.

I read before that depending on the TIPS interest crediting time, the yield for shorter term tips would be thrown off?

Would that be the case for the 01/15/2024 maturing TIPS?
I don't know what you mean by "TIPS interest crediting time", but there is a seasonality effect that causes weird shapes in the yield curve. By adjusting for the seasonality, the yield curve is smoothed out to more what we'd expect. For an ask yield of 0.39% for the 1/15/2024 TIPS (quote from Fidelity today), the seasonally adjusted yield is 0.12%.

Kevin
Thanks Kevin. How is the seasonal adjusted yield calculated?

Also, does the seasonal adjustment affect the shorter term TIPS more than longer term TIPS?
I walk through the calculations starting in this post: Seasonal adjustment example: CPI NS and SL. There are two other posts that continue the example--search for "seasonal adjustment example" to find them (there are a few interspersed replies mixed in).

Yes, the seasonality effect is much more pronounced in shorter-term TIPS, having very little effect on longer-term TIPS.

Kevin
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Re: Trading Treasuries (nominal and TIPS)

Post by drzzzzz »

Kevin,
If one is buying tips on the secondary market, is seasonality something that I need to be concerned about or do I just look for highest yield to worst/yield to maturity return in the time frame that I want? And is a higher or lower inflation factor preferred or does that not really matter? Is the inflation factor factored into what the site calls yield to worst/yield to maturity data that is presented on the Fidelity webiste?. thanks
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

drzzzzz wrote: Thu Aug 11, 2022 1:55 pm Kevin,
If one is buying tips on the secondary market, is seasonality something that I need to be concerned about or do I just look for highest yield to worst/yield to maturity return in the time frame that I want? And is a higher or lower inflation factor preferred or does that not really matter? Is the inflation factor factored into what the site calls yield to worst/yield to maturity data that is presented on the Fidelity webiste?. thanks
If the yields are generally increasing, but are higher or lower than expected for a particular maturity, then probably most of that is seasonality. For example, the 7/15/2023 ask yield is weirdly low compared to the 4/15/2023 and 1/15/2024, but I would be just as happy buying the 7/15/2023 as the 4/15/2023 based on the seasonally adjusted values:

Image

From the chart we see that it's actually the 4/15/2023 and 1/15/2024 ask yields are weirdly high, and the 7/15/2023 SA yield is pretty close to the ask yield. That's because settlement mm/dd for today's purchase is closer to 7/15, and the seasonal adjustments are smaller the closer settlement mm/dd is to maturity mm/dd. When settlement mm/dd matches maturity mm/dd, the adjustment is 0 if we use the 2022 SA factors to do the adjustment.

I believe the seasonal adjustment rationalizes the yields based on the expected nominal returns, since lower inflation due to seasonal effects will decrease the nominal return of a TIPS, and vice versa.

Yield to worst is always the same as Yield to maturity for Treasuries (nominal and TIPS), since they are not callable. So we can just look at YTM.

Some people prefer lower inflation factor because it reduces possible nominal losses during extended deflation. Others don't think extended deflation is a likely enough scenario to worry about it. We had tiny deflation in July (-0.01% month over month), which will mean tiny negative inflation adjustment for September for all TIPS, regardless of inflation factor (they all are > 1). I believe the 1/15/2023 yield jumped so much yesterday because of this, and the concern that there might be additional deflation, or at least lower inflation than previously expected, in subsequent months.

The inflation factor is not factored into the yield to maturity, since it is a real yield. The real price (the one you see quoted when you buy) is multiplied by the inflation factor to get the adjusted price, which is what you pay. There is no rational way to calculate a standard yield to maturity for the adjusted price, since we don't know what the future nominal cash flows will be, as they are determined by inflation.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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Re: Trading Treasuries (nominal and TIPS)

Post by MisterMister »

I don't want to precipitate a discussion here about I-Bonds because this topic is about trading treasuries, and I-Bonds can't be traded. But I know many treasury investors here also have, or are interested in, I-Bonds.

Spouses can gift each other 10K in I-Bonds. If your recipient is already at max purchase for the year, you can transfer the gift next year (that would also go to next year's max). The advantage of buying now is that you will get 9.62% for your first six months, and you start earning that interest now. Also, the one-year hold on redemption starts when you buy. I believe you can buy as late as October and still get that 9.62% rate for your first six months.

If you have any comments or questions, there's already another thread devoted to the topic:
viewtopic.php?t=365140

A useful tutorial is here:
https://www.youtube.com/watch?v=bSoZJJypSAQ&t=34s
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Re: Trading Treasuries (nominal and TIPS)

Post by LadyGeek »

I-Bonds should be discussed here: I Bonds Mega Thread (I Bond Heads Rejoice!)

Please stay on-topic, which is about trading Treasuries.
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Re: Trading Treasuries (nominal and TIPS)

Post by bpg1234 »

Kevin M wrote: Thu Aug 11, 2022 2:59 pm
drzzzzz wrote: Thu Aug 11, 2022 1:55 pm Kevin,
If one is buying tips on the secondary market, is seasonality something that I need to be concerned about or do I just look for highest yield to worst/yield to maturity return in the time frame that I want? And is a higher or lower inflation factor preferred or does that not really matter? Is the inflation factor factored into what the site calls yield to worst/yield to maturity data that is presented on the Fidelity webiste?. thanks
If the yields are generally increasing, but are higher or lower than expected for a particular maturity, then probably most of that is seasonality. For example, the 7/15/2023 ask yield is weirdly low compared to the 4/15/2023 and 1/15/2024, but I would be just as happy buying the 7/15/2023 as the 4/15/2023 based on the seasonally adjusted values:

Image

From the chart we see that it's actually the 4/15/2023 and 1/15/2024 ask yields are weirdly high, and the 7/15/2023 SA yield is pretty close to the ask yield. That's because settlement mm/dd for today's purchase is closer to 7/15, and the seasonal adjustments are smaller the closer settlement mm/dd is to maturity mm/dd. When settlement mm/dd matches maturity mm/dd, the adjustment is 0 if we use the 2022 SA factors to do the adjustment.

I believe the seasonal adjustment rationalizes the yields based on the expected nominal returns, since lower inflation due to seasonal effects will decrease the nominal return of a TIPS, and vice versa.

Yield to worst is always the same as Yield to maturity for Treasuries (nominal and TIPS), since they are not callable. So we can just look at YTM.

Some people prefer lower inflation factor because it reduces possible nominal losses during extended deflation. Others don't think extended deflation is a likely enough scenario to worry about it. We had tiny deflation in July (-0.01% month over month), which will mean tiny negative inflation adjustment for September for all TIPS, regardless of inflation factor (they all are > 1). I believe the 1/15/2023 yield jumped so much yesterday because of this, and the concern that there might be additional deflation, or at least lower inflation than previously expected, in subsequent months.

The inflation factor is not factored into the yield to maturity, since it is a real yield. The real price (the one you see quoted when you buy) is multiplied by the inflation factor to get the adjusted price, which is what you pay. There is no rational way to calculate a standard yield to maturity for the adjusted price, since we don't know what the future nominal cash flows will be, as they are determined by inflation.

Kevin
Kevin,

Still trying to wrap my head around some of this so please bear with me. The 7/15/23 TIPS real yield is positive today (.093 as I write this for small quanity) so with the slight negative CPI this month and the potential for some additional CPI decreases if inflation moderates further does buying say $10K face at a purchase price of 12,674.57 ($3.99 accrued interest) raise any concern?

Thanks,
bpg
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Re: Trading Treasuries (nominal and TIPS)

Post by bpg1234 »

Kevin,

Another clarity/learning question, I purchased another $10K of the 4/25 TIPS yesterday at yield of .351 for price of $11,307.51 (which includes $4.74 of accrued interest) and today the same 4/25 TIPS is yielding .376 but for a higher price of $11,315.43.

The inflation factor today is slightly higher (1.13863 vs 1.13783 yesterday) which I attribute to the increased price? From an understanding perspective, would a purchase today at the higher overall price $11,315.43 but .376 real yield been better versus yesterday's with the reduced purchase price of $11,307.51 but lower real yield of .351?

Thanks,
bpg
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Re: Trading Treasuries (nominal and TIPS)

Post by make_a_better_world »

I want to say thank you to Kevin. I learned a great deal from this thread and purchased some T-bills on the secondary market inside Vanguard this morning, which I did not know how to do before.
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Re: Trading Treasuries (nominal and TIPS)

Post by protagonist »

make_a_better_world wrote: Fri Aug 12, 2022 11:14 am I want to say thank you to Kevin. I learned a great deal from this thread and purchased some T-bills on the secondary market inside Vanguard this morning, which I did not know how to do before.
I also think I can speak for the whole group in thanking you, Kevin. Your broad expertise combined with your selfless willingness to help others has likely helped everybody here navigate the choppy waters of fixed income in the 2020s....newbies and seasoned investors alike.
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Re: Trading Treasuries (nominal and TIPS)

Post by BL »

protagonist wrote: Fri Aug 12, 2022 11:23 am
make_a_better_world wrote: Fri Aug 12, 2022 11:14 am I want to say thank you to Kevin. I learned a great deal from this thread and purchased some T-bills on the secondary market inside Vanguard this morning, which I did not know how to do before.
I also think I can speak for the whole group in thanking you, Kevin. Your broad expertise combined with your selfless willingness to help others has likely helped everybody here navigate the choppy waters of fixed income in the 2020s....newbies and seasoned investors alike.
+1
I have purchased treasuries and CDs at V thanks to Kevin. Still trying to figure out TIPS, but that is ok.
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

bpg1234 wrote: Fri Aug 12, 2022 9:43 am Kevin,

Another clarity/learning question, I purchased another $10K of the 4/25 TIPS yesterday at yield of .351 for price of $11,307.51 (which includes $4.74 of accrued interest) and today the same 4/25 TIPS is yielding .376 but for a higher price of $11,315.43.

The inflation factor today is slightly higher (1.13863 vs 1.13783 yesterday) which I attribute to the increased price? From an understanding perspective, would a purchase today at the higher overall price $11,315.43 but .376 real yield been better versus yesterday's with the reduced purchase price of $11,307.51 but lower real yield of .351?

Thanks,
bpg
I'll use prices downloaded from Fidelity yesterday and today, so slightly different than yours, but the results will be similar.

The inflation factor increased by 0.13%, while the real price changed by -0.05%, so the total principal (not including accrued interest) increased by 0.08%.

I would prefer to buy at a lower price and higher yield, even if the total cost is more. I have shared a few of my TIPS purchases where this is the case--it's actually quite common for my purchases.

Kevin
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Re: Trading Treasuries (nominal and TIPS)

Post by bpg1234 »

Kevin M wrote: Fri Aug 12, 2022 1:01 pm
bpg1234 wrote: Fri Aug 12, 2022 9:43 am Kevin,

Another clarity/learning question, I purchased another $10K of the 4/25 TIPS yesterday at yield of .351 for price of $11,307.51 (which includes $4.74 of accrued interest) and today the same 4/25 TIPS is yielding .376 but for a higher price of $11,315.43.

The inflation factor today is slightly higher (1.13863 vs 1.13783 yesterday) which I attribute to the increased price? From an understanding perspective, would a purchase today at the higher overall price $11,315.43 but .376 real yield been better versus yesterday's with the reduced purchase price of $11,307.51 but lower real yield of .351?

Thanks,
bpg
I'll use prices downloaded from Fidelity yesterday and today, so slightly different than yours, but the results will be similar.

The inflation factor increased by 0.13%, while the real price changed by -0.05%, so the total principal (not including accrued interest) increased by 0.08%.

I would prefer to buy at a lower price and higher yield, even if the total cost is more. I have shared a few of my TIPS purchases where this is the case--it's actually quite common for my purchases.

Kevin
Thanks Kevin as usual for your response. You indicate you prefer to buy at a lower price and higher yield so then if I understand correctly you're saying a purchase today may be better than yesterday even though it cost more. How does this potentially materialize into a higher dollar amount at maturity if the purchase price now is higher for the same $10K face value of TIPS?
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

bpg1234 wrote: Fri Aug 12, 2022 9:22 am Still trying to wrap my head around some of this so please bear with me. The 7/15/23 TIPS real yield is positive today (.093 as I write this for small quanity) so with the slight negative CPI this month and the potential for some additional CPI decreases if inflation moderates further does buying say $10K face at a purchase price of 12,674.57 ($3.99 accrued interest) raise any concern?

Thanks,
bpg
I just downloaded quotes from Fidelity, and I have 0.09% as the large-quantity ask yield (although it's already dropped to 0.07%), which is -0.01% seasonally adjusted.

The index ratio is 1.26380, so you could potentially lose up to 21% in nominal terms if net deflation over the term was more than 21%.

We will have a -0.01% inflation adjustment for September. This will affect all TIPS the same, since the lowest index ratio is 1.01226 (for the 7/15/2032 TIPS), so could lose up to about 1% if there is net deflation from now until 7/15/2032. So for deflation down to about 1%, all TIPS will be affected the same (if held to maturity).

The average index ratio for all outstanding TIPS is 1.22466, so it's tough to avoid the deflation risk if you are buying a broad range of TIPS. At least one poster has mentioned buying the TIPS with the lowest IR for each maturity in their ladder. I haven't been doing that.

For TIPS with maturities up to 7/15/2027 (about 5 years), the average IR is 1.23392.

The positive spin is that if there is deflation, the cost of things is going down on average, so the purchasing power of your TIPS is not declining (other than due to negative real yield).

Kevin
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Re: Trading Treasuries (nominal and TIPS)

Post by protagonist »

Kevin M wrote: Fri Aug 12, 2022 1:22 pm

The positive spin is that if there is deflation, the cost of things is going down on average, so the purchasing power of your TIPS is not declining (other than due to negative real yield).

Kevin
Right, and something people tend to overlook. If you wind up with less than what you invested, but if deflation more than compensates for that, you still "win" in terms of purchasing power. When there was deflation in the early days of COVID and we were earning essentially zero interest in our bank accounts we were still winning. Only "real" gain or loss matters, not nominal.
That said, I suppose if you purchase at a high premium you could theoretically still lose a fair amount with persistent deflation. Though I have not been compulsive about it, I try to purchase TIPS at a price below 100. I have bought a few at prices slightly higher. If two close in maturity with fairly similar yield are very discrepant in price , I will buy the lower priced one, not the one with the slightly higher yield.
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

bpg1234 wrote: Fri Aug 12, 2022 1:17 pm Thanks Kevin as usual for your response. You indicate you prefer to buy at a lower price and higher yield so then if I understand correctly you're saying a purchase today may be better than yesterday even though it cost more. How does this potentially materialize into a higher dollar amount at maturity if the purchase price now is higher for the same $10K face value of TIPS?
That's a great question, and I hadn't really looked into it before. At this point I can't provide a great answer, but can share some observations.

I did a cash flow analysis on two 1/15/2023 TIPS I bought:

10 on 7/13/2022 (settlement) at 100.910, real yield = -1.66% and SA real yield = -2.24%, and total price = 12,700.33.

10 on 8/8/2022 (settlement) at 100.390, real yield = -0.77% and SA real yield = -1.65% and total price = 12,753.21.

The real internal rates of return are close the the real yields, as expected, at -1.64% and -0.74% respectively.

However, the nominal IRR obviously depends on the inflation rate. If my analysis is correct, if inflation is below a certain level, the nominal return of the first purchase (lower real yield) is higher, even though the the real return is lower. I think in this case it might be related to seasonality, as the seasonally adjusted (SA) yield for the first purchase was 58 basis points lower, while for the second purchase it was 89 basis points lower.

With inflation of 2.29% (8.07% annualized) between 10/1/2022 (last know ref CPI date) and 1/15/2023, the nominal returns are about the same, at 7.00% and 7.01% respectively. If the inflation rate is lower than that, the nominal return for purchase 1 is higher, and vice versa. I don't know if it's a coincidence, but the conventional BEI was 2.31% based on TIPS yields pulled from Fidelity just before the close.

Here is a screenshot of my calculated results with the 2.29% assumed inflation rate between Oct 1 and Jan 15 2023.

Image

Note: the return and APY for the first purchase ignore the earlier date of the 7/15/22 interest payment, so they are not exact, but quite close.

I may try this on another one where the seasonality isn't as much of an issue, and perhaps #Cruncher would be interested in weighing in on this.

Kevin
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Re: Trading Treasuries (nominal and TIPS)

Post by bpg1234 »

Kevin M wrote: Fri Aug 12, 2022 8:11 pm
bpg1234 wrote: Fri Aug 12, 2022 1:17 pm Thanks Kevin as usual for your response. You indicate you prefer to buy at a lower price and higher yield so then if I understand correctly you're saying a purchase today may be better than yesterday even though it cost more. How does this potentially materialize into a higher dollar amount at maturity if the purchase price now is higher for the same $10K face value of TIPS?
That's a great question, and I hadn't really looked into it before. At this point I can't provide a great answer, but can share some observations.

I did a cash flow analysis on two 1/15/2023 TIPS I bought:

10 on 7/13/2022 (settlement) at 100.910, real yield = -1.66% and SA real yield = -2.24%, and total price = 12,700.33.

10 on 8/8/2022 (settlement) at 100.390, real yield = -0.77% and SA real yield = -1.65% and total price = 12,753.21.

The real internal rates of return are close the the real yields, as expected, at -1.64% and -0.74% respectively.

However, the nominal IRR obviously depends on the inflation rate. If my analysis is correct, if inflation is below a certain level, the nominal return of the first purchase (lower real yield) is higher, even though the the real return is lower. I think in this case it might be related to seasonality, as the seasonally adjusted (SA) yield for the first purchase was 58 basis points lower, while for the second purchase it was 89 basis points lower.

With inflation of 2.29% (8.07% annualized) between 10/1/2022 (last know ref CPI date) and 1/15/2023, the nominal returns are about the same, at 7.00% and 7.01% respectively. If the inflation rate is lower than that, the nominal return for purchase 1 is higher, and vice versa. I don't know if it's a coincidence, but the conventional BEI was 2.31% based on TIPS yields pulled from Fidelity just before the close.

Here is a screenshot of my calculated results with the 2.29% assumed inflation rate between Oct 1 and Jan 15 2023.

Image

Note: the return and APY for the first purchase ignore the earlier date of the 7/15/22 interest payment, so they are not exact, but quite close.

I may try this on another one where the seasonality isn't as much of an issue, and perhaps #Cruncher would be interested in weighing in on this.

Kevin
Thanks Kevin for this thorough analysis.
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Re: Trading Treasuries (nominal and TIPS)

Post by Doc »

protagonist wrote: Fri Aug 12, 2022 7:27 pm by protagonist » Fri Aug 12, 2022 7:27 pm

Kevin M wrote: ↑Fri Aug 12, 2022 1:22 pm


The positive spin is that if there is deflation, the cost of things is going down on average, so the purchasing power of your TIPS is not declining (other than due to negative real yield).

Kevin
Right, and something people tend to overlook. If you wind up with less than what you invested, but if deflation more than compensates for that, you still "win" in terms of purchasing power. When there was deflation in the early days of COVID and we were earning essentially zero interest in our bank accounts we were still winning. Only "real" gain or loss matters, not nominal.
I disagree.

TIPS are a protection against unexpected inflation. Expected inflation is already "built in" with nominals.

We've been talking short term. I also win with nominals in short term deflation. The FED is rasing interest rates to bring inflation down. The price of goods is going down and I don't have to pay the "insurance premium" for the TIPS. So I win twice with nominals in the short term.

Long term TIPS is a different story with respect to inflation. But given the terrible under performance of TIPS compared to nominals in the 2008 September/October stock market crash I personally can do without long term TIPS also.

(Caveat: We do not have a liability matching portfolio. We have a "for the grandchildren" portfolio.)
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Re: Trading Treasuries (nominal and TIPS)

Post by billyt »

I don't think you can totally discount the possibility that prices after a while go back to where they were a year ago. If so, some recently purchased TIPS will be in a world of hurt!
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Re: Trading Treasuries (nominal and TIPS)

Post by billyt »

TIPS compensate for actual realized inflation, regardless of what the market expects. Regular treasuries have no such compensation mechanism. I don't think market expectations of inflation have any bearing on the matter.
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Re: Trading Treasuries (nominal and TIPS)

Post by dbr »

billyt wrote: Sat Aug 13, 2022 12:41 pm TIPS compensate for actual realized inflation, regardless of what the market expects. Regular treasuries have no such compensation mechanism. I don't think market expectations of inflation have any bearing on the matter.
Indeed. It is just baffling why the essentially correct comment that nominals have expected inflation "baked" in somehow gets turned around to imply that TIPS are not compensated when the inflation was "expected."
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Re: Trading Treasuries (nominal and TIPS)

Post by dbr »

billyt wrote: Sat Aug 13, 2022 12:41 pm TIPS compensate for actual realized inflation, regardless of what the market expects. Regular treasuries have no such compensation mechanism. I don't think market expectations of inflation have any bearing on the matter.
Indeed. It is just baffling why the essentially correct comment that nominals have expected inflation "baked" in somehow gets turned around to imply that TIPS are not compensated when the inflation was "expected." Does anyone know if there is some analysis that show this to actually happen somehow.
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Re: Trading Treasuries (nominal and TIPS)

Post by silvergga »

Just want to thank everyone especially Kevin for answering questions and providing info as always!

I haven’t had much “total bond” since a few years ago when Kevin discussed about secondary market CDs.

Back then I moved most of my retirement account’s “bond” allocation to CDs. Then moved to a ~2% stable value as they matured.

Was able to avoid the bond fund dip recently.

Now that even Vanguard money market is 2%, and my stable value is still 1.8%, I am having 50% of my “bond” portion going to 3.35% 2-yr CD. And the other 50% into ~2 yr TIPs with ~0% real.
Last edited by silvergga on Sat Aug 13, 2022 1:04 pm, edited 2 times in total.
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

dbr wrote: Sat Aug 13, 2022 12:52 pm
billyt wrote: Sat Aug 13, 2022 12:41 pm TIPS compensate for actual realized inflation, regardless of what the market expects. Regular treasuries have no such compensation mechanism. I don't think market expectations of inflation have any bearing on the matter.
Indeed. It is just baffling why the essentially correct comment that nominals have expected inflation "baked" in somehow gets turned around to imply that TIPS are not compensated when the inflation was "expected." Does anyone know if there is some analysis that show this to actually happen somehow.
Can you elaborate on what kind of analysis you mean?

It's easy to show that you receive the real return you signed up for, but the nominal returns can be puzzling compared to the real returns, as I showed above (assuming my calculations are correct). I think much of the latter is due to seasonal affects on CPI.
If I make a calculation error, #Cruncher probably will let me know.
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Re: Trading Treasuries (nominal and TIPS)

Post by dbr »

Kevin M wrote: Sat Aug 13, 2022 1:01 pm
dbr wrote: Sat Aug 13, 2022 12:52 pm
billyt wrote: Sat Aug 13, 2022 12:41 pm TIPS compensate for actual realized inflation, regardless of what the market expects. Regular treasuries have no such compensation mechanism. I don't think market expectations of inflation have any bearing on the matter.
Indeed. It is just baffling why the essentially correct comment that nominals have expected inflation "baked" in somehow gets turned around to imply that TIPS are not compensated when the inflation was "expected." Does anyone know if there is some analysis that show this to actually happen somehow.
Can you elaborate on what kind of analysis you mean?

It's easy to show that you receive the real return you signed up for, but the nominal returns can be puzzling compared to the real returns, as I showed above (assuming my calculations are correct). I think much of the latter is due to seasonal affects on CPI.
I don't know. That is why I am asking. It is obvious that the canard that TIPS are not compensated for expected inflation is just that, a canard.

I suppose that if expected inflation is defined as the difference between nominal and real yields on similar bonds, then that is the analysis and it says TIPS are in fact compensated for expected inflation because you are getting the real yield, that, as you say, you signed up for, no matter the inflation, saving a couple of conditions about deflation.

Why are there people who consistently seem to imply that TIPS are not compensated for expected inflation usually in the form of something like nominals anticipate expected inflation while TIPS are "for" unexpected inflation. Is the problem that people have to stop assigning to bonds that this, that, or the other bond is "for" something in particular.
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Re: Trading Treasuries (nominal and TIPS)

Post by MisterMister »

Kevin M wrote: Sat Aug 13, 2022 1:01 pm
dbr wrote: Sat Aug 13, 2022 12:52 pm
billyt wrote: Sat Aug 13, 2022 12:41 pm TIPS compensate for actual realized inflation, regardless of what the market expects. Regular treasuries have no such compensation mechanism. I don't think market expectations of inflation have any bearing on the matter.
Indeed. It is just baffling why the essentially correct comment that nominals have expected inflation "baked" in somehow gets turned around to imply that TIPS are not compensated when the inflation was "expected." Does anyone know if there is some analysis that show this to actually happen somehow.
Can you elaborate on what kind of analysis you mean?

It's easy to show that you receive the real return you signed up for, but the nominal returns can be puzzling compared to the real returns, as I showed above (assuming my calculations are correct). I think much of the latter is due to seasonal affects on CPI.
Not sure how you mean the nominal return can be puzzling; I'm not clear on SA impact on TIPS so that’s something I need to learn about. But I have recently been working on creating spreadsheets similar to your own. The relationship between the real return and the nominal one (XIRR) seems clear below.Image

Note, though, the annualized 4% inflation rate I show is annualized over the same period as the security (settlement to maturity vs yours which shows Oct 1 to Jan 15). The items highlighted in orange show the relationship.

It could be I misunderstand where there's confusion. TIPs results for a given price/yield certainly do reflect the actuality of inflation (rather than expectations) as shown by CPI.

As I say I am still learning so I hope I've not made any mistakes here. The spreadsheet was originally done just for my own benefit as an aid to confirm what I’m learning from you and others here.

EDIT: Harry Sit's book on TIPS has a variety of illustrative spreadsheets on TIPS as well. It's been alluded to here but here is a direct link for anyone who's interested https://thefinancebuff.com/explore-tips.
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Re: Trading Treasuries (nominal and TIPS)

Post by #Cruncher »

bpg1234 wrote: Fri Aug 12, 2022 9:43 am... would a purchase today at the higher overall price $11,315.43 but .376 real yield been better versus yesterday's with the reduced purchase price of $11,307.51 but lower real yield of .351?
Kevin M wrote: Fri Aug 12, 2022 1:01 pmI would prefer to buy at a lower price and higher yield, even if the total cost is more.
bpg1234 wrote: Fri Aug 12, 2022 1:17 pm... you're saying a purchase today may be better than yesterday even though it cost more. How does this potentially materialize into a higher dollar amount at maturity ...?
Kevin M wrote: Fri Aug 12, 2022 8:11 pmThat's a great question, and I hadn't really looked into it before. At this point I can't provide a great answer, but can share some observations.
You're overthinking this, Kevin. The answer to bpg1234's question is simply, "It doesn't." The future interest and principal proceeds will be the same regardless of the cost of purchase. So buying for less is better regardless of why the cost is less. It would have paid to delay from Thursday to Friday unless one would have earned more than the $7.92 cost difference over three days (Friday to Monday settlement) on the $11,307.51 cost of Thursday's purchase.

Of course this is academic, since on Thursday one doesn't know what the price will be on Friday.

In looking into this, I realized that increasing index ratios during August will have a significant effect on the yield of this TIPS even though it doesn't mature until April 15, 2025. (The effect will be greater for TIPS that mature sooner.) I assume that the TIPS will be priced to have an expected nominal return of 3.2%, the yield-to-maturity (YTM) of nominal Treasury notes & bonds maturing about April 2025. (See WSJ Treasury Quotes.) I also assume on Thursday (Friday 8/12/2022 settlement) this TIPS had a YTM of 0.35%, as stated in bpg1234's 10:43 AM post. To simplify calculations, I treat this TIPS as if it had a 0% coupon with annual (365 day) compounding.

The right-hand column below shows my calculated YTM for this TIPS for each workday from August 12 to September 30 assuming it is priced to keep the nominal 3.2% return and 122.5646 nominal value at maturity calculated in cell B8. Note how the YTM increases about 0.1% point each week from 8/12 to 9/1; but then decreases about 0.02% points each week from 9/1 to 9/30.

Code: Select all

  1               Settles  8/12/2022
  2               Matures  4/15/2025
  3     Yield to maturity      0.35%
  4      Unadjusted price    99.0691   =100/(1+B3)^((B2-B1)/365)
  5  Idx ratio settlement    1.13713   =VLOOKUP(B1,$A$11:$C$46,3,FALSE)
  6        Adjusted price   112.6545   =B4*B5
  7        Nominal return      3.20%
  8  Nominal mature value   122.5646   =B6*(1+B7)^((B2-B1)/365)
Row                 Col A      Col B     Col C     Col D   Col E
  9                         Adjusted     Index     Unadj         
 10               Settles      Price     Ratio     Price    YTM

Code: Select all

 11           Fri 8/12/22   112.6545   1.13713   99.0691   0.35% 
 12           Mon 8/15/22   112.6837   1.13863   98.9643   0.39% 
 13           Tue 8/16/22   112.6934   1.13913   98.9294   0.40% 
 14           Wed 8/17/22   112.7031   1.13963   98.8945   0.42% 
 15           Thu 8/18/22   112.7128   1.14013   98.8596   0.43% 
 16           Fri 8/19/22   112.7226   1.14064   98.8240   0.45%
 
 17           Mon 8/22/22   112.7518   1.14214   98.7197   0.49% 
 18           Tue 8/23/22   112.7615   1.14264   98.6851   0.50% 
 19           Wed 8/24/22   112.7712   1.14314   98.6504   0.52% 
 20           Thu 8/25/22   112.7810   1.14364   98.6158   0.53% 
 21           Fri 8/26/22   112.7907   1.14415   98.5803   0.54%
 
 22           Mon 8/29/22   112.8199   1.14565   98.4768   0.59% 
 23           Tue 8/30/22   112.8296   1.14615   98.4423   0.60% 
 24           Wed 8/31/22   112.8394   1.14665   98.4079   0.61% 
 25           Thu 9/01/22   112.8491   1.14715   98.3734   0.63%
 
 26           Fri 9/02/22   112.8588   1.14715   98.3819   0.62% 
 27           Mon 9/05/22   112.8881   1.14714   98.4083   0.62% 
 28           Tue 9/06/22   112.8978   1.14713   98.4176   0.61% 
 29           Wed 9/07/22   112.9075   1.14713   98.4261   0.61% 
 30           Thu 9/08/22   112.9173   1.14712   98.4355   0.61% 
 31           Fri 9/09/22   112.9270   1.14712   98.4440   0.61%
 
 32           Mon 9/12/22   112.9563   1.14710   98.4712   0.60% 
 33           Tue 9/13/22   112.9660   1.14710   98.4797   0.59% 
 34           Wed 9/14/22   112.9758   1.14710   98.4882   0.59% 
 35           Thu 9/15/22   112.9855   1.14709   98.4975   0.59% 
 36           Fri 9/16/22   112.9953   1.14709   98.5060   0.58%
 
 37           Mon 9/19/22   113.0245   1.14707   98.5332   0.58% 
 38           Tue 9/20/22   113.0343   1.14707   98.5418   0.57% 
 39           Wed 9/21/22   113.0440   1.14706   98.5511   0.57% 
 40           Thu 9/22/22   113.0538   1.14706   98.5596   0.57% 
 41           Fri 9/23/22   113.0636   1.14705   98.5690   0.56%
 
 42           Mon 9/26/22   113.0928   1.14704   98.5954   0.56% 
 43           Tue 9/27/22   113.1026   1.14704   98.6039   0.55% 
 44           Wed 9/28/22   113.1124   1.14703   98.6132   0.55% 
 45           Thu 9/29/22   113.1221   1.14703   98.6218   0.55% 
 46           Fri 9/30/22   113.1319   1.14702   98.6311   0.54%
Notes for cells A11:E46:
  1. I calculated for very workday from Aug 12 to Sept 30. During September the Reference CPI declines slightly from 296.311 to 296.276 after the large increase during August from 292.296 to 296.311. (See this web page.)
  2. Adjusted Price calculated given the assumed 122.5646 nominal value on the 4/15/2025 maturity (cell B8). For example:
    B11: 112.6545 = B$8/(1+B$7)^((B$2-A11)/365)
  3. Index Ratios 8/12 to 9/30 from this web page.
  4. Unadjusted Price backed into:
    D11: 99.0691 = B11/C11
  5. YTM calculated based on unadjusted price assuming zero coupon and annual (365 day) compounding.
    E11: 0.35% = (100/D11)^(365/(B$2-A11))-1
Of course both the assumed 3.2% nominal return and the assumed future CPI needed to produce the 122.5646 nominal value at maturity on 4/15/2025 (calculated in cell B8) can change during the period. But the table above shows that the daily YTM of this TIPS changes even if these remain the same.
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Re: Trading Treasuries (nominal and TIPS)

Post by jeffyscott »

#Cruncher wrote: Sun Aug 14, 2022 7:38 am The right-hand column below shows my calculated YTM for this TIPS for each workday from August 12 to September 30 assuming it is priced to keep the nominal 3.2% return and 122.5646 nominal value at maturity calculated in cell B8. Note how the YTM increases about 0.1% point each week from 8/12 to 9/1; but then decreases about 0.02% points each week from 9/1 to 9/30.
So if someone is looking at this TIPS tomorrow and the reported real YTM is 0.39%, should they be thinking as if they are actually buying at a real YTM of about 0.54%, since that is what we know the real yield would become as of Sept. 30, if nothing else that would influence TIPS yields/prices were to change over that time period?
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Re: Trading Treasuries (nominal and TIPS)

Post by BlueEars »

Doc wrote: Sat Aug 13, 2022 11:50 am
protagonist wrote: Fri Aug 12, 2022 7:27 pm by protagonist » Fri Aug 12, 2022 7:27 pm

Kevin M wrote: ↑Fri Aug 12, 2022 1:22 pm


The positive spin is that if there is deflation, the cost of things is going down on average, so the purchasing power of your TIPS is not declining (other than due to negative real yield).

Kevin
Right, and something people tend to overlook. If you wind up with less than what you invested, but if deflation more than compensates for that, you still "win" in terms of purchasing power. When there was deflation in the early days of COVID and we were earning essentially zero interest in our bank accounts we were still winning. Only "real" gain or loss matters, not nominal.
I disagree.

TIPS are a protection against unexpected inflation. Expected inflation is already "built in" with nominals.

We've been talking short term. I also win with nominals in short term deflation. The FED is rasing interest rates to bring inflation down. The price of goods is going down and I don't have to pay the "insurance premium" for the TIPS. So I win twice with nominals in the short term.

Long term TIPS is a different story with respect to inflation. But given the terrible under performance of TIPS compared to nominals in the 2008 September/October stock market crash I personally can do without long term TIPS also.

(Caveat: We do not have a liability matching portfolio. We have a "for the grandchildren" portfolio.)
But what about the 5 year TIPS? Kind of in between short and long term. I had 10 year TIPS in 2008 and remember that unpleasant ride which added to equity losses. I don't know how 5 yr TIPS responded back then.

Did you see my chart comparing 5 yr Treasuries and 5 yr TIPS about 3 pages back? See below for it again.

Also with inflation being so poorly modeled, how can we expect that the market gets in right in pricing intermediate Treasuries?

Interested in your perspective Doc (and others perspective here too).


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Re: Trading Treasuries (nominal and TIPS)

Post by protagonist »

An aside....I found this very interesting. Via another thread I was linked to a portfolio backtest comparison site. It made me curious what would have happened with a 50-50 stock-bond portfolio compared with a similar portfolio replacing the Total US Bond portion with TIPS. . I typed in the longest allowed investment period, 1972-2022. The calculator automatically replaced the 1972-2022 time range with 2001-2022 due to lack of prior TIPS data I expected that the 50/50 stocks/total US bond portfolio would have outperformed, but in fact, the 50/50 stocks/TIPS won out by quite a margin (and with considerable less risk). ( https://www.portfoliovisualizer.com/bac ... sisResults)

Unfortunately the link seems broken so if you want to check this , or compare with other portfolio combinations, you need to go to https://www.portfoliovisualizer.com yourself.

Those here who are familiar with my posts know that I am the last person to believe the relevance of past performance data when projecting ahead...that said, I found it interesting (and counterintuitive, especially during a bond bull market with declining interest rates since 2001).
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Re: Trading Treasuries (nominal and TIPS)

Post by BlueEars »

Hi Protagonist, what does the tool use for the TIPS choice?

Oops, I found it and it is VIPSX. Average effective maturity = 7.6 years.
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Re: Trading Treasuries (nominal and TIPS)

Post by Doc »

BlueEars wrote: Sun Aug 14, 2022 9:44 am But what about the 5 year TIPS? Kind of in between short and long term. I had 10 year TIPS in 2008 and remember that unpleasant ride which added to equity losses. I don't know how 5 yr TIPS responded back then.

Did you see my chart comparing 5 yr Treasuries and 5 yr TIPS about 3 pages back? See below for it again.

Also with inflation being so poorly modeled, how can we expect that the market gets in right in pricing intermediate Treasuries?

Interested in your perspective Doc (and others perspective here too).
I am not currently interested in intermediate term fixed income. The FED is raising interest rates by some 50 bps per FOMC meeting. With that kind of expected change I don't care about intermediate term for my current investment choices. My 4-7 Treasury ladder went to T-Bills some time ago when the curve flattened. My 1-3 Treasury funds went to a 0-3 ladder because I got tired of dealing with the nickel and dime distributions every month in five different accounts. With the Fed's current direction I am replacing maturing rungs of my ladder with T-Bills of different lengths.

An alternative to those T-Bills (ladders) could be short term TIPS bought on the secondary market.

Since I am buying only very short term I am not worried about inflation especially since the FED is raising rates to fight inflation. Kevin's idea of short term TIPS seems inconsistent with the Fed's inflation fighting.

Just looking for ideas.
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Re: Trading Treasuries (nominal and TIPS)

Post by BlueEars »

Doc wrote: Sun Aug 14, 2022 12:16 pm
BlueEars wrote: Sun Aug 14, 2022 9:44 am But what about the 5 year TIPS? Kind of in between short and long term. I had 10 year TIPS in 2008 and remember that unpleasant ride which added to equity losses. I don't know how 5 yr TIPS responded back then.

Did you see my chart comparing 5 yr Treasuries and 5 yr TIPS about 3 pages back? See below for it again.

Also with inflation being so poorly modeled, how can we expect that the market gets in right in pricing intermediate Treasuries?

Interested in your perspective Doc (and others perspective here too).
I am not currently interested in intermediate term fixed income. The FED is raising interest rates by some 50 bps per FOMC meeting. With that kind of expected change I don't care about intermediate term for my current investment choices. My 4-7 Treasury ladder went to T-Bills some time ago when the curve flattened. My 1-3 Treasury funds went to a 0-3 ladder because I got tired of dealing with the nickel and dime distributions every month in five different accounts. With the Fed's current direction I am replacing maturing rungs of my ladder with T-Bills of different lengths.

An alternative to those T-Bills (ladders) could be short term TIPS bought on the secondary market.

Since I am buying only very short term I am not worried about inflation especially since the FED is raising rates to fight inflation. Kevin's idea of short term TIPS seems inconsistent with the Fed's inflation fighting.

Just looking for ideas.
What level of 5yr TIPS would you be a buyer at? Currently they are at 0.3%. Independent of what the Fed is doing, I am thinking there is some level to consider intermediate term TIPS a buy. I don't have a clue as to how 5yr Tips react to Fed rate hikes although a guess is they would go somewhat higher.

I should add, the last time I bought 5yr TIPS in Oct 2018 they were at 1.0% while the 5 yr Treasury was at 3.0%. Currently the 5yr Treasury is at around 3.0%.
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Re: Trading Treasuries (nominal and TIPS)

Post by Doc »

BlueEars wrote: Sun Aug 14, 2022 12:32 pm What level of 5yr TIPS would you be a buyer at?
None.

1) We don't have a liability matching portfolio.

2) Boglehead's mantra was TIPS are "just like nominals except for the inflation protection". Then along came the 2008 market crash and TIPS crashed along with stocks. I had to sell our entire TIPS ladder to rebalance and never went back.

If we did have a liability matching portfolio the "level" of TIPS would be irrelevant when the FED is raising interest rates by 50 bps every 8 weeks in order to reduce inflation which also reduces that TIPS return along with it.

(To be clear if we did still have a TIPS position I wouldn't necessarily be selling it now either.)
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Re: Trading Treasuries (nominal and TIPS)

Post by BlueEars »

Doc wrote: Sun Aug 14, 2022 2:06 pm
BlueEars wrote: Sun Aug 14, 2022 12:32 pm What level of 5yr TIPS would you be a buyer at?
None.

1) We don't have a liability matching portfolio.

2) Boglehead's mantra was TIPS are "just like nominals except for the inflation protection". Then along came the 2008 market crash and TIPS crashed along with stocks. I had to sell our entire TIPS ladder to rebalance and never went back.

If we did have a liability matching portfolio the "level" of TIPS would be irrelevant when the FED is raising interest rates by 50 bps every 8 weeks in order to reduce inflation which also reduces that TIPS return along with it.

(To be clear if we did still have a TIPS position I wouldn't necessarily be selling it now either.)
We don't have a liability matching portfolio either. Just trying to get some real return from the FI side. We have 20% of FI in 3.4% ibonds and probably could hold as much as 60% of FI in bonds with the remaining 20% of FI in higher liquidity bonds for rebalancing stocks and spending.

So for us it seems that a good percentage of positive yielding 5yr TIPS held to maturity would work out fine. Some of that 60% of FI in bonds could also be in a switch strategy between short term investment grade and intermediate Treasuries but that is a very non-Bogleheadian idea.
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

#Cruncher wrote: Sun Aug 14, 2022 7:38 am
bpg1234 wrote: Fri Aug 12, 2022 9:43 am... would a purchase today at the higher overall price $11,315.43 but .376 real yield been better versus yesterday's with the reduced purchase price of $11,307.51 but lower real yield of .351?
Kevin M wrote: Fri Aug 12, 2022 1:01 pmI would prefer to buy at a lower price and higher yield, even if the total cost is more.
bpg1234 wrote: Fri Aug 12, 2022 1:17 pm... you're saying a purchase today may be better than yesterday even though it cost more. How does this potentially materialize into a higher dollar amount at maturity ...?
Kevin M wrote: Fri Aug 12, 2022 8:11 pmThat's a great question, and I hadn't really looked into it before. At this point I can't provide a great answer, but can share some observations.
You're overthinking this, Kevin. The answer to bpg1234's question is simply, "It doesn't." The future interest and principal proceeds will be the same regardless of the cost of purchase. So buying for less is better regardless of why the cost is less. It would have paid to delay from Thursday to Friday unless one would have earned more than the $7.92 cost difference over three days (Friday to Monday settlement) on the $11,307.51 cost of Thursday's purchase.
Glad you jumped in. The issue I have is that it's not intuitive to me that a higher real yield could result in a lower nominal return. How would you explain this to someone without crunching the numbers?

Although I didn't really answer bpg1234's question, the analysis I did showed that the nominal return could be higher or lower for a lower real yield, higher cost purchase, depending on inflation. I'm wondering if there's an error in my calculations, or if this is correct.

Here is the scenario where inflation is high enough for the higher cost purchase to have a higher nominal return:

Image

And here is low inflation where the lower cost, lower real yield nominal return is higher:

Image

Thanks,

Kevin
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Re: Trading Treasuries (nominal and TIPS)

Post by Doc »

BlueEars wrote: Sun Aug 14, 2022 2:47 pm We don't have a liability matching portfolio either. Just trying to get some real return from the FI side. We have 20% of FI in 3.4% ibonds and probably could hold as much as 60% of FI in bonds with the remaining 20% of FI in higher liquidity bonds for rebalancing stocks and spending.

So for us it seems that a good percentage of positive yielding 5yr TIPS held to maturity would work out fine. Some of that 60% of FI in bonds could also be in a switch strategy between short term investment grade and intermediate Treasuries but that is a very non-Bogleheadian idea.
I don't think a positive real return is possible in todays market without taking on a lot of default risk.

About the only thinking that one can do is to stay short term and wait.

My difference from the short term TIPS advocates is there is little if anything to gain with the FED raising the Federal funds rate some 50 to 75 bps every FOMC meeting. If the FED succeeds in lowering the inflation rate which we all want, you get little benefit if any from short TIPS over short nominals. My vote is go for the liquidity with nominals. I haven't heard anything form the (very) short TIPS advocates.
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Re: Trading Treasuries (nominal and TIPS)

Post by jeffyscott »

Doc wrote: Sun Aug 14, 2022 5:04 pm I don't think a positive real return is possible in todays market without taking on a lot of default risk.
The real yield of every TIPS was positive on of Friday, based on WSJ quotes.
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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

jeffyscott wrote: Sun Aug 14, 2022 5:11 pm
Doc wrote: Sun Aug 14, 2022 5:04 pm I don't think a positive real return is possible in todays market without taking on a lot of default risk.
The real yield of every TIPS was positive on of Friday, based on WSJ quotes.
Right, but the seasonally-adjusted yields of the 1/15/2023 through 7/15/2023 still are negative:

Image

Of course you will earn the unadjusted real yield if you hold to maturity, but the expected nominal return is lower than if the seasonal adjustment was not so large.

Zooming in to the shorter maturities:

Image

EDIT: The important point is that you can indeed earn a positive real return on any TIPS (as of Friday), including the shortest maturities, with essentially no default risk. It doesn't matter what the FOMC does, or whether or not there is net inflation or deflation over the term to maturity--you will earn a positive real return.

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Re: Trading Treasuries (nominal and TIPS)

Post by Kevin M »

Doc wrote: Sun Aug 14, 2022 5:04 pm I don't think a positive real return is possible in todays market without taking on a lot of default risk.

About the only thinking that one can do is to stay short term and wait.

My difference from the short term TIPS advocates is there is little if anything to gain with the FED raising the Federal funds rate some 50 to 75 bps every FOMC meeting. If the FED succeeds in lowering the inflation rate which we all want, you get little benefit if any from short TIPS over short nominals. My vote is go for the liquidity with nominals. I haven't heard anything form the (very) short TIPS advocates.
I spoke with my money on Friday, and bought more of the 4/15/2023 TIPS. I paid 100.200 for a yield of +0.32% (-0.47% SA). I did not buy any more nominals, but as I've said, more than half of my 2022 fixed income purchases have been nominal Treasuries or box spreads, although a bunch is maturing/expiring next Friday.

We don't know what the Fed will do, we don't know how successful they'll be at driving down inflation, and we don't know how that will affect real yields, so I'm sticking with my 50/50 TIPS/nominals target for 2022 additions for now, but probably will overweight very short-term nominals (mostly with box spreads) if short-term TIPS yields don't increase.

I'll also continue to keep a healthy amount in money market funds, as the top yielding ones are paying almost as much as a 1-month Treasury.

So, I'll continue to have plenty of liquidity--much more than I need, as I'm quite a bit over target for equities, so probably won't be rebalancing into them anytime soon. As I've said many, many times before in discussions about this with you, you can have plenty of liquidity for rebalancing with nominal Treasuries without holding 100% of fixed income in nominal Treasuries.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
itispossible
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Re: Trading Treasuries (nominal and TIPS)

Post by itispossible »

I am new to buying treasuries and am trying to compute my tax-equivalent yield for different options. Can someone please confirm if this is right?

Fed marginal rate is 32%
NY state marginal rate is 6.85%

Vanguard New York Municipal Money Market Fund (VYFXX) -- current yield is 1.6%
Vanguard Treasury Money Market Fund (VUSXX) -- current yield is 1.8%
Vanguard Federal Money Market Fund (VMFXX) -- current yield is 2.11%

Are these the tax-equivalent yields?

VYFXX: 2.62% [=1.6%/(1-32%-6.85%)]
VUSXX: 2.00% [=1.8%(1-32%)/(1-32%-6.85%)]
VMFXX -- not sure because I do not know about state tax implication for it.

Also, is there any downside to purchasing VYFXX?

Would appreciate your response. Thanks.

** corrected
Last edited by itispossible on Sun Aug 14, 2022 9:21 pm, edited 2 times in total.
MisterMister
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Re: Trading Treasuries (nominal and TIPS)

Post by MisterMister »

itispossible wrote: Sun Aug 14, 2022 7:42 pm I am new to buying treasuries and am trying to compute my tax-equivalent yield for different options. Can someone please confirm if this is right?

Fed marginal rate is 32%
NY state marginal rate is 6.85%

Vanguard New York Municipal Money Market Fund (VYFXX) -- current yield is 1.6%
Vanguard Treasury Money Market Fund (VUSXX) -- current yield is 1.8%
Vanguard Federal Money Market Fund (VMFXX) -- current yield is 2.11%

Are these the tax-equivalent yields?

VYFXX: 2.62% [=1.6%/(1-32%-6.85%)]
VUSXX: 1.93% [=1.8%/(1-6.85%)]
VMFXX -- not sure because I do not know about state tax implication for it.

Also, is there any downside to purchasing VYFXX?

Would appreciate your response. Thanks.
I don't think that's quite right. You will net (100%-32%) of money only taxable at the fed level, compared with (100%-32%-6.85%) for income taxable to both federal and state. So the TEY is (1 - .32)/(1 - .32 - .0685) times the yield (this for income taxable to fed, but not taxable to state).

EDIT: According to a Google search VYFXX seeks income that is not federally or state taxable.

So if that's the case for VYFXX it would be 1.6% x / (1 - .32 - .0685)] or 2.62% as you noted.

VUSXX should be subject ONLY to federal tax, so that one would be

1.93% x [(1 - .32)/(1 - .32 - .0685)] or 2.146%

Can't answer about the downside of VYFXX but I'm sure someone will chime in.

Someone posted a bunch of TEY formula (may have been Kevin) on BH somewhere. I don't remember exactly where but try searching for TEY. If so, I'm sure he'll correct me if I'm wrong here.
Last edited by MisterMister on Sun Aug 14, 2022 8:58 pm, edited 3 times in total.
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jeffyscott
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Re: Trading Treasuries (nominal and TIPS)

Post by jeffyscott »

^I've never understood the point of calculating taxable equivalent yield, why not just calculate the after tax yield of each investment?
MisterMister
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Re: Trading Treasuries (nominal and TIPS)

Post by MisterMister »

jeffyscott wrote: Sun Aug 14, 2022 8:21 pm ^I've never understood the point of calculating taxable equivalent yield, why not just calculate the after tax yield of each investment?
I guess because then you'd have to do two calculations instead of one?

Usually with TEY you're comparing something that's not state taxable like treasuries to something that's fully taxable like bank interest. And assuming your federal and state margins are not changing it's the same adjustment to the yield each time.
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jeffyscott
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Re: Trading Treasuries (nominal and TIPS)

Post by jeffyscott »

MisterMister wrote: Sun Aug 14, 2022 8:35 pm
jeffyscott wrote: Sun Aug 14, 2022 8:21 pm ^I've never understood the point of calculating taxable equivalent yield, why not just calculate the after tax yield of each investment?
I guess because then you'd have to do two calculations instead of one?
But the two calculations are simple and intuitively obvious. I don't have to remember an odd formula or wonder if I am doing it correctly.
MisterMister
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Re: Trading Treasuries (nominal and TIPS)

Post by MisterMister »

^You make a good point.
itispossible
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Re: Trading Treasuries (nominal and TIPS)

Post by itispossible »

Thanks mistermister
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