TIPS program now 21; Treasury may tweak it
The $1.3 trillion U.S. market for inflation-linked debt, the brainchild of former Treasury Secretary Larry Summers, has saved taxpayers billions of dollars. Now, as the program turns 21, it may need a tuneup.
In an assessment released this month, the current stewards of the nation’s finances saw both pros and cons to Treasury Inflation Protected Securities — known as TIPS — which were introduced in January 1997. On the plus side, the debt has saved about $49 billion relative to sales of regular notes and bonds. Yet Treasury Secretary Steven Mnuchin’s team expressed disappointment that the obligations have not attracted a more diversified group of investors.
Summers, Robert Rubin’s deputy at the time TIPS were brought in and later head of the Treasury Department, calls the securities “a clear success.” But some Wall Street strategists predict changes ahead, such as to the auction calendar, sizes or maturities. The Treasury has a history of adapting its issuance lineup, including shrinking TIPS sales. Aligning its offerings with investor needs is more important than ever as the U.S. faces mounting budget deficits.
There’s a risk, however, that any decision to curb TIPS issuance comes just as inflation finally starts to take off, leaving bond investors with a diminished toolkit for hedging.
“I thought it was a good idea to diversify the Treasury’s funding base, to provide people with the option of inflation insurance and for establishing a market indicator for measuring inflation expectations,” said Summers, now a Harvard University professor. “All three of those things have been borne out over time. And $49 billion is a good savings.”
The Treasury’s analysis of TIPS, released ahead of this month’s quarterly debt offerings, came at a critical time for the nation’s fiscal overseers: The Federal Reserve has begun to let Treasurys roll off its $4.5 trillion balance sheet, and U.S. budget deficits are expected to climb, even without taking into account potential tax cuts. That means the $14.3 trillion government bond market is ready to grow.
In its Nov. 1 refunding documents, the Treasury said it expected to announce an increase to nominal coupon-bearing securities and floating-rate debt in February to help meet rising funding needs. Yet it gave no signal that it intended to boost TIPS sales.
“It does seem like for the time being Treasury is not that keen on TIPS issuance,” said Stephen Stanley, chief economist at Amherst Pierpont Securities. “The support or enthusiasm in the market for TIPS is much less than it would otherwise be because people don’t believe we are ever going to get any inflation.”
Thirty-year TIPS show that bond traders expect consumer prices will rise at just under a 2 percent annual rate for the next three decades. Meanwhile, the Fed is sticking to projections that inflation will soon rise to that level, although it’s mostly been below it since 2012.
While there is persistent buying of longer maturities, last month’s 30-year TIPS auction still drew robust demand even as price pressures remain muted. The result was welcome news to bond dealers, in part because the securities are seen as relatively thinly traded and thus harder to unload. Investors get their next crack at buying the debt this week, when Treasury auctions 10-year TIPS.
In a sign that TIPS haven’t attracted significant new buyers to the nation’s debt, investment funds — including mutual and hedge funds, asset managers and investment advisers — have bought most of both TIPS and nominal Treasurys since 2012, department data show. In both cases, dealers were the second-biggest buyers.
“It’s no secret that liquidity in TIPS is an issue,” said Subadra Rajappa, head of U.S. rates strategy at Société Générale. “Treasury seems to be saying that sponsorship in TIPS is clearly an issue, with not the kind of breadth of participation from counterparties they would have expected, which leaves it open to changes by Treasury as they see fit.”