Sign of faith in Fed? Yield on inflation-protected Treasurys dips below zero

By Cordell Eddings and Daniel Kruger
Tuesday, October 26, 2010

The Treasury sold $10 billion of five-year Treasury Inflation Protected Securities at a negative yield for the first time at a U.S. debt auction Monday as investors bet that the Federal Reserve will succeed in its bid to jump-start the faltering economy.

The securities drew a yield of negative 0.55 percent in a sale that was a reopening of an $11 billion offering in April.

Holders of TIPS receive an adjustment to the principal value of their securities equal to the change in the consumer price index, a widely used gauge of inflation. That adjustment is in addition to a fixed rate of interest that's smaller than the interest paid to a holder of a conventional Treasury security, such as a 10-year bond.

The fixed payment on five-year TIPS - known as the real yield - has been pushed below zero because the rise in the consumer price index is greater than the yield on regular five-year U.S. government notes, which has fallen with other Treasury yields as investors seek the safety of U.S. government debt.

The Fed has indicated in recent weeks that it is preparing to take extraordinary steps to shore up the economy by purchasing large amounts of government debt, a tactic known as quantitative easing, which is aimed at lowering interest rates across the economy.

A negative yield suggests investors are betting that the Fed's intervention is likely to successfully prevent deflation and reduce the risk of the economy slipping back into recession.

"It signals people's expectation of the Fed being able to create some inflation with the [quantitative easing] program," said Alex Li, an interest-rate strategist in New York at Deutsche Bank, which as a primary dealer is required to bid at Treasury auctions. "With nominal rates so low, in order have high TIPS break-evens you've got to have negative real yields on the five-year."

The United States can only sell TIPS at a negative yield, according to McKayla Barden, a spokeswoman at the Bureau of the Public Debt. It's not government policy to auction conventional debt at that level, she said. The last five-year TIPS auction, on April 26, drew a yield of 0.55 percent, which was then the lowest on record.

Federal Reserve Chairman Ben S. Bernanke said at a conference two weeks ago that the economy might need more stimulus because inflation is too low and unemployment too high at 9.6 percent. Core prices, which exclude food and fuel, were little changed in September, capping a 0.8 percent increase in the past 12 months, the smallest year-over-year gain since 1961. The Fed's policymaking committee meets again on Nov. 2 and 3.

Although central banks are typically more concerned about faster inflation, the worst financial crisis since the Great Depression has made sustained price declines a bigger concern. Fed policymakers, who have already cut interest rates almost to zero and bought $1.7 trillion of securities since the onset of the financial crisis, are discussing additional purchases of Treasurys to flood markets with cheap money and prevent stagnating prices from undermining the recovery.

"There is a lot of thought going into trying to figure out what the Fed is going to do," said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus, a St. Louis-based brokerage. "The differing views minute to minute are causing Treasurys to run up and down, with most people preferring to sit on their hands until the news is handed down."

- Bloomberg News

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