TIPS Attract Weakest Demand Since 2001

U.S. Treasury auction of inflation-linked bonds had lowest bid-to-cover ratio in over a dozen years, reflecting expectations that inflation will remain low.

The U.S. sale of $9 billion in 30-year Treasury Inflation Protected Securities (TIPS) drew the weakest demand in a dozen years amid stagnant inflation and as the Federal Reserve reduces its bond purchases.

The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.34, the lowest level since a sale in October 2001, the last offering before the U.S. suspended sales of the security for almost a decade. Auctions resumed in February 2010. The 30-year TIPS sold yesterday yielded 1.495 percent, the most since June 2011. The average forecast of seven of the Fed’s 22 primary dealers in a Bloomberg News poll was a yield of 1.463 percent.

“The basis of strong buying of TIPS has to be stronger inflation before investors are enticed back into the market, and we just aren’t seeing much,” said Aaron Kohli, an interest-rate strategist in New York at BNP Paribas SA, which as a primary dealer is obligated to bid in U.S. debt sales. “The big takeaway from a weaker auction is that investors are willing to buy, but a greater concession is needed or real inflation pressures need to step up.”

The yield on the current 30-year inflation-indexed bond rose four basis points, or 0.04 percentage point, to 1.49 percent yesterday in New York. TIPS pay interest at lower rates than nominal Treasuries on a principal amount that’s linked to the Labor Department’s consumer price index.

TIPS due in 15 years and longer have returned 3.4 percent this year through Feb. 19, after losing 19.4 percent in 2013, their worst year on record, according to Bank of America Merrill Lynch’s 15-Plus Year U.S. Inflation-Linked Treasury Index. The broader Treasury market has gained 1.5 percent this year, compared with a 3.4 percent drop in 2013, according to the Merrill Lynch U.S. Treasury Index.

The Fed, citing economic improvement, has reduced its monthly bond-buying to $65 billion in $10 billion cuts ordered at each of its past two policy meetings. Fed Chair Janet Yellen told U.S. lawmakers Feb. 11 she would scale back purchases in “measured steps” and only a “notable change” in economic prospects would prompt a slowing in the pace. The buying was designed to cap long-term borrowing costs and fuel growth.

The CPI increased 0.1 percent in January after a 0.2 percent gain the prior month, which was smaller than initially reported, a Labor Department report showed yesterday in Washington. The index rose 1.6 percent from a year earlier, versus 1.5 percent in December.


Bidder Participation

Indirect bidders, a category of investors that includes foreign central banks, bought 56.5 percent of the securities at yesterday’s TIPS sale, the most since the June auction. That compared with an average of 44.5 percent at the past 10 auctions.

Direct bidders, non-primary-dealer investors that place their bids directly with the Treasury, purchased 4.9 percent of the securities, versus a 17.3 percent average at the past 10 offerings.

The difference between yields on 30-year bonds and similar-maturity TIPS, a gauge of the outlook for consumer prices over the life of the debt known as the break-even rate, narrowed to 2.26 percentage points. The average for the past decade is 2.47 percentage points.

“At these real-yield levels, investors are more hesitant about taking on significant levels of duration,” said Michael Pond, head of global inflation-linked research at the primary dealer Barclays Plc. “The decline in the bid-to-cover reflects the general weakness in demand we’ve seen at Treasury auctions this year. Higher yields will bring investors back.” Duration is a measure of sensitivity to movements in interest rates.

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