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Monday, November 8, 2010

TIPS Sell For A Negative Rate

This story was interesting. At a recent 5-year TIPS Treasury auction, an inflation-indexed bond sold for a negative rate of -0.55%. More precisely, the coupon was 0.5%, but the banksters bid more than the face amount. Summarizing, someone paid $10k*1.0055^5 for a $10k face amount bond.

That headline was misleading. What it actually means is that, over the next 5 years, (the annualized future CPI plus 1.005%) is expected to be greater than the current 5 year Treasury rate.

The TIPS bond is, in effect, a CPI futures contract. If you believe that the future CPI will be higher than the rate implied by TIPS, then you buy TIPS and short sell Treasury bonds. If you believe the reverse, then you buy Treasury bonds and short sell TIPS.

Of course, this trade is only available to the banksters. They get preferential treatment when buying and short-selling Treasury debt.

The TIPS bond is based on the CPI, and not on real inflation. As a retail investor, you'd be an idiot to buy a TIPS bond. You'd be robbed by inflation. True inflation is much greater than the CPI.

How does a TIPS bond work? Suppose you buy a TIPS bond for $1M. The nominal annual coupon is 0.5%, $5000.

Suppose that the CPI over the next year is 1%. The TIPS bond adjusts. The principal due at maturity is increased by 1% to $1.01M. The annual coupon is increased by 1% to $5050.

"Expected future CPI over the next 5 years plus 0.5% nominal yield" is greater than "current 5 year Treasury bond yield". Therefore, the banksters were willing to pay a negative current rate. When you add expected CPI adjustments, it comes to the same yield as a 5 year bond.

Based on the auction price, the "breakeven" CPI is 1.6%. If the CPI comes out to that amount over the next 5 years, then the TIPS bond would have the same total yield as a 5 year vanilla bond. If it's less, then the TIPS bond would have been a bad investment. If it's more, then the TIPS bond would have been a good investment (relative to a 5 year vanilla Treasury bond, but still worse than true inflation). For this reason, the TIPS bond is logically equivalent to a CPI futures contract.

The CPI is biased. The CPI is much less than true inflation. Based on gold/silver/corn/wheat/oil/commodities, I estimate true inflation to be 20%-30% or more.

"TIPS sold for negative rate" shows what a farce the US financial system is. The Federal Reserve keeps interest rates below the fake CPI rate. State comedians can't even keep that lie consistent.

Negative real interest rates cause bubbles. Where will the next bubble be? Will it be a total hyperifnaltionary collapse? There's nothing specific I see. It seems like a "corruption bubble" is forming. In the USA, stealing is *WAY* more profitable than performing useful work.

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