For any long-term investment, taking the future rate of inflation into account is paramount. The reason for this is because inflation eats into the expected returns. Thus, if you could find a way to insulate your investments from this, you most definitely will. The goal of any inflation-protected investment is to ensure that you are cushioned from the reduction in the purchasing power.
Understanding the US 10-Year TIPS Auction
TIPS refers to Treasury Inflation-Protected Securities. As the name suggests, these are US government-issued securities meant to provide investors with protection against the effects of inflation.
US 10-Year TIPS are Inflation-Protected treasury bonds issued by the US Department of the Treasury. The principal on these bonds is meant to finance spending activities by the US government and is redeemable after ten years.
TIPS auction refers to the sale of the inflation-protected treasury bonds by the US Department of Treasury. Originally, the 10-Year US TIPS are auctioned twice a year – in January and July. The reopening auctions are done in March, May, September, and November. Thus, these auctions are scheduled every two months.
Discount rate: The percentage difference between the price at which the TIPS is bought at auction and the one at which it can be redeemed.
Maturity: For the US Treasury Inflation-Protected Securities, the maturity period refers to the maximum time an investor can hold the bonds before redemption. These bonds are usually issued with a maturity period of 5, 10, and 30 years from the auction date. Usually, the minimum duration of ownership is 45 days. Therefore, one can choose to sell their TIPS before maturity or hold them until maturity.
How to Buy TIPS
TIPS can only be bought in electronic form. The minimum amount of TIPS one can purchase is $100 and increments of $100 after that. The maximum amount that a bidder can purchase in a single auction is $5 million. During the auction, the interest rate on the TIPS is determined by the competitive buyers.
The competitive bidders usually specify the yield that they are willing to accept. The competitive bidders for TIPS are large buyers such as brokerage firms, investment firms, and banks. The competitive bidders set the yield for the TIPS, which requires one to have an in-depth knowledge of the money markets. Competitive bidders are required to submit the number of TIPS they intend to buy and the return on investment they seek. This return is the discount rate.
Not all competitive bids are accepted at the auction. When the competitive bid is equal to the high yield, less than the full amount wanted by an investor might be accepted. The bid might be entirely rejected if it is higher than the yield accepted during the auction. The non-competitive bidders are regarded as “takers” of the yield set by the winning competitive bidders.
Once the bidding process is over, the treasury distributes the issuance. Let’s say, for example, that in an auction, the US Department of Treasury is auctioning $20 billion worth of TIPS. If the non-competitive bids are worth $5 billion, they are all accepted. The remaining $15 billion is then distributed among the competitive bidders. The lower competitive bids are filled first until the $15 billion is exhausted.
Using the US 10-Year TIPS Auction for Analysis
Since the TIPS’s primary goal is to safeguard against the effects of inflation, the interest rate paid on them can be used as an indicator of possible inflation rates in the future.
Before we explain how the US 10-year TIPS auctions can be used for analysis, here are two things you need to keep in mind.
- TIPS’s interest rate is paid semi-annually at a fixed rate, which is usually based on the adjusted principal.
- Whenever inflation rises, the interest rate rises, and when there is deflation, the interest rate drops.
Once TIPS have been auctioned and traded in the secondary market, when inflation in the economy rises, the principal on TIPS increases as well. Thus, the interest rate payable on these TIPS increases as well. During the TIPS’ subsequent issues, the interest rate payable will reflect the prevailing rate of inflation. Furthermore, the discount rate set at the auctions can be used to gauge the level of confidence that investors have in the US economy. The lower discount rate shows that the current investment atmosphere in the economy is risky; hence, investors are willing to take lower returns than risk losing their principal in other markets.
On the other hand, when investors can get better returns in other markets within the economy, they would demand a higher discount rate. Furthermore, when there is deflation in the economy, the principal on the TIPS falls along with the interest rates payable.
Impact on Currency
Theoretically, the auction of the US 10-year TIPS can impact the currency in two ways. By showing the confidence level in the economy and by showing the prevailing rates of inflation.
When the interest rate payable on the TIPS increases, it shows that the levels are increasing. This increase shows that the economy is growing, which is good for the currency. Furthermore, the higher discount rate at auctions implies that investors can get better rates elsewhere in the economy.
Conversely, the currency will depreciate relative to others when TIPS’s interest rate decreases, which implies that there is deflation in the economy. This instance can also play out if discount rates at the auction are at historical lows. It shows that the economy is performing poorly and that investors may not get better returns elsewhere.
Sources of Data
US Department of Treasury is responsible for the auction of the US 10-year TIPS. The data of the latest TIPS auction can be accessed from Treasury Direct. Treasury Direct also publishes data on the upcoming TIPS auction, which can be accessed here.
St. Louis FRED publishes an in-depth series of the US 10-year TIPS.
Source: St. Louis FRED
How US 10-Year TIPS Auction Affects the Forex Price Charts
The most recent auction of the US 10-year TIPS was on September 17, 2020, at 1.00 PM EST. The data on the auction can be accessed at Investing.com. The US 10-Year TIPS auction is expected to have a low impact on the USD, as shown by the screengrab below.
During the recent auction, the rate for the 10-year TIPS was -0.996% compared to -0.930% on the July auction.
Let’s see what impact this release had on the USD.
EUR/USD: Before US 10-Year TIPS Auction on September 17, 2020, Just Before 1.00 PM EST
Before the auction, the EUR/USD pair went from trading in a steady uptrend to a subdued uptrend. The 20-period MA can be seen going from a steep rise to almost flattening as the candles formed just above it.
EUR/USD: After US 10-Year TIPS Auction on September 17, 2020, at 1.00 PM EST
Immediately after the release of the auction data, the pair formed a 5-minute “Doji” candle. Subsequently, the EUR/USD pair continued to trade in the subdued uptrend with candles forming just above an almost flattened 20-period MA.
From these analyses, we can establish that the US 10-year tips auction has no significant impact on the forex price charts. The reason for this could be because most forex traders do not keep an eye on bond auctions but instead focus on more mainstream indicators like the CPI and GDP.