Econoday Why Investors Care

2005 U.S. Economic Events & Analysis

Resource Center » U.S. & International Recaps | Release Dates | Why Investors Care | Today's Calendar

20-Year TIPS Announcement

Definition
The Treasury sells inflation-indexed securities, also known as TIPS, at regularly scheduled auctions. Competitive bids at these single-price auctions determine the interest rate paid on each issue, which remains fixed. Twenty-two primary dealers (as of August 2004) are authorized and obligated to submit competitive tenders at Treasury auctions. Dealers can hold, resell, or trade the securities with other firms. The Treasury usually announces the amount, date and time of the 20-year TIPS auction in the third week of January. The reopening is usually announced in the third week of July. In both cases, 20-year TIPS are usually auctioned in the last week of the month. These TIPS are issued (settled) on the last business day of the month. These TIPS, however, have a mid-month maturity date. Consequently, investors who purchase these securities at auction are required to pay the interest accrued between the 15th of the month and the issue date. The 20-year issue in July 2004 had an initial maturity date of 20 1/2 years and was reopened in January and July 2005.

Why Investors Care?
Individual investors can participate in Treasury auctions through a securities dealer or via the Treasury Direct program. Though the Treasury Direct program saves on brokerage commissions, commissions are often nominal and eliminate a lot of paper work and administrative hassle. Brokers facilitate the purchase and sale of Treasuries in the secondary market, which is handy for buying Treasuries at times other than scheduled auctions or with maturities other than those offered by standard new issues.

Interest rates on Treasury securities are determined in the market; the Federal Reserve does not set them. However, bond investors are sensitive to Federal Reserve policy and thus market rates will mirror policy expectations. Usually, bond market players are forward-looking and this means that interest rates on Treasury securities will move in the direction of Fed policy with a lead. As a result, one is more likely to see rising interest rates on Treasury yields during an expansion (and falling yields during economic slowdowns) in advance of policy changes by the Federal Reserve.

TIPS, inflation-indexed securities, are designed to shield investors from inflation-risk. The principal is adjusted for inflation. Instead of getting back your initial investment of $1,000, for instance, you would get $1,000 plus an additional amount tied to the inflation rate. Since there is no inflation premium on the interest rate, interest payments (and yields attached to the TIPS) are lower than for regular Treasury securities. Economists and policymakers consider the differential between yields on 20-year TIPS and regular 20-year bonds to be a proxy for investors' estimate of inflation expectations. Actually, the Treasury does not offer regular 20-year bonds, but the Fed calculates yields for 20-year constant maturity securities.