Daily Treasury Real Yield Curve Rates
December 14, 2011
5-Year: -0.74%
7-Year: -0.42%
10-Year: -0.04%
20-Year: 0.53%
30-Year: 0.73%
Here's the premise. Let's say that you are a saver and wish to own inflation protected treasuries for 30 years. What's the optimal way to play the yield curve?
1. You could buy the 30-year TIPS and just lock in the 0.73% real yield. Little math needed. You know what you get.
1.0073^30 = 1.244
2. You could buy the 20-year TIPS and earn 0.53% for the next 20 years. You'd need to earn 1.14% per year for the remaining 10 years to match the return of the 30-year TIPS.
(1.0053^20) * (1.0114^10) = 1.245
3. You could buy the 10-year TIPS and earn -0.04% for the next 10 years. You'd need to earn 1.12% per year for the remaining 20 years to match the return of the 30-year TIPS.
(0.9996^10) * (1.0112^20) = 1.245
4. You could buy the 7-year TIPS and earn -0.42% for the next 7 years. You'd need to earn 1.09% per year for the remaining 23 years to match the return of the 30-year TIPS.
(0.9958^7) * (1.0109^23) = 1.246
5. You could buy the 5-year TIPS and earn -0.74% for the next 5 years. You'd need to earn 1.03% per year for the remaining 25 years to match the return of the 30-year TIPS.
(0.9926^5) * (1.0103^25) = 1.245
Only hindsight will tell us which option was best. Options 2-5 do require higher real yields in the future (between 1.03% and 1.14%). They may come. They may not.
So what does this really mean?
Not only is the bond market suggesting that the next 5 years will treat savers poorly, it isn't exactly predicting great things for the 25 years that follow either.
I think the bond market is pretty much in line with my own predictions at this point. For what it is worth, I think the death of real yields has probably run its course. For all intents and purposes, real yields are now dead. That doesn't mean that I expect rates to move higher from here. I don't. If I had to guess, I'd say rates will stagnate (to match our economy). Could be wrong of course. It is just a guess.
And lastly, let's go back in time to when Jeremy Siegel warned us not to buy TIPS.
February 2, 2011
5-Year: 0.09%
7-Year: 0.68%
10-Year: 1.16%
20-Year: 1.82%
30-Year: 2.10%
Oops. In hindsight, 2.10% in the hand was worth more than today's 0.73% in the ivory tower. Who knew? Now savers (and pension funds?) are praying for 1% real yields. Well, there's always hope.
And for those in stocks, the next Rubicon moment in the S&P 500 should be along within a couple days.
ReplyDeleteWho Struck John,
ReplyDeleteAre you suggesting that there will be a 31st crossing of the Rubicon? What an amazingly bold prediction! ;)
Mark,
ReplyDeletecould you have added ibonds and even e bonds to that metric? I am thinking of grabbing e bonds next week as the allocation for both has been reduced to 5k in 2012. I may be wrong, but 10k in e bonds look better over 20 years.
I'd appreciate your thoughts.
I don't know how many Rubicon crossings lie ahead of us. I do feel that we are getting closer to the final crossing and it will be on the down-side.
ReplyDeleteNot ultimate-final, just for-a-long-time final.
The DJI top in 1929 wasn't hit again until 1954. That kind of final.
WASF!
JzB
fried,
ReplyDelete10k in e bonds could be better but you better know what inflation will do. I bonds are a bit more inflation agnostic.
That said, the bond market says you are right (using inflation expectations in the TIPS market). Further, I did buy e bonds this year and last.
I would have included it in my analysis here but I think it pretty much goes without saying that 0.00% i bonds are better than -0.74% 5-year TIPS (and for more reasons than just the difference in interest rates).
Jazzbumpa,
ReplyDeleteI don't know how many Rubicon crossings lie ahead of us. I do feel that we are getting closer to the final crossing and it will be on the down-side.
You could be right. If I knew the stock market would simply trade sideways then I would probably prefer it over 0% i bonds. That's only if I knew though.
I'm not willing to take the risk that you are right. It is certainly a non-trivial one.