Treasury Inflation-Protected Securities (TIPS)

Office of Debt Management

U.S. Treasury Department
August 2008
TIPS Market Overview

• The U.S. Treasury is the largest issuer of inflation linked bonds globally.

• There are 27 issues outstanding ranging in tenor from 2009 to 2032.

• A full, liquid real rate curve exists out to 10 years.

• To date only three TIPS issues have matured – the Jul 2002, Jan 2007, and Jan 2008
issues.

• As of July 31, 2008, TIPS outstanding totaled over $515 billion; or about 11% of
marketable Treasuries outstanding.

• Average daily trading volume of TIPS by primary dealers in 2008 is close to $9

billion.1

1
Estimates provided by Federal Reserve Bank of New York.
Office of Debt Management
2
TIPS Component of the Treasury Debt Portfolio as of July 31, 2008
$9.6 Trillion in Debt Outstanding
SLGS Series, $266,
3% Savings Bonds, $195,
TIPS, $517, 5%
2%
Bonds, $581, 6%

Notes, $2,575, 27%

Government Account
Series, $4,266, 45%

(In billions)

Bills, $1,136, 12% $4.8 Trillion in Non-Marketable Debt Outstanding

$4.8 Trillion in Marketable Debt Outstanding
R.E.A. Series, $0, 0% Foreign Series, $3, 0%
TIPS, $517, 11%
Bills, $1,136, 24% Domestic Series, $30, SLGS Series, $266,
1% 6%

Savings Bonds, $195,

Bonds, $581, 12% 4%

Office of Debt Management (In billions) Government Account (In billions)

Notes, $2,575, 53% Series, $4,266, 89%
3
TIPS Issuance and Schedules

• TIPS were first auctioned in January 1997 with a tenor of 10 years.

• At the May 2004 Quarterly Refunding, to provide additional funding, Treasury
announced the reintroduction of the 5-year TIPS and the initiation of the 20-year
TIPS1.
• Current TIPS Auction Schedule:
• Semi-Annual 10-Year (Jan, Jul) with a Quarterly reopening (Apr, Oct)
• Annual 20-Year (Jan) with a Semi-Annual reopening (Jul)
• Annual 5-Year (Apr) with a Semi-Annual reopening (Oct)

1
Due to lower borrowing needs resulting from an improving budget, the 5-year TIPS was discontinued in
Sept 1998, and the 30-year TIPS was discontinued in Oct 2001.
Office of Debt Management
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Historical TIPS Securities Issuance and Amount Outstanding

TIPS Annual Issuance and Outstanding

90 500
30-Year (LHS)
80 20-Year (LHS) 450
10-Year (LHS)
70 400
5-Year (LHS)
Inflation-Adjusted Outstanding (RHS) 350
60
300
$ billions

$ billions
50
250
40
200
30
150
20 100

10 50

0 0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Calendar Year

Office of Debt Management

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Primary Dealer Trading Activity in TIPS
Average Daily Transactions in TIPS by Primary Dealers

$20
Average Daily Transactions (LHS)
$18

$16
Transactions in Billions of $

$14

$12

$10

$8

$6

$4

$2

$
1/28/1998

7/28/1998

1/28/1999

7/28/1999

1/28/2000

7/28/2000

1/28/2001

7/28/2001

1/28/2002

7/28/2002

1/28/2003

7/28/2003

1/28/2004

7/28/2004

1/28/2005

7/28/2005

1/28/2006

7/28/2006

1/28/2007

7/28/2007

1/28/2008
Source: Federal Reserve Bank of New York
Week
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Participation in 10-Year TIPS Auctions by Investor Class

TIPS Investor Participation - 10 YR

Depository Institutions Individuals Dealers and Brokers
Pension and Retirement Investment Funds Foreign

80%

70%

60%

50%

40%

30%

20%

10%

0%
Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08
Office of Debt Management
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Participation in 5- and 20-Year TIPS Auctions by Investor Class
TIPS Investor Participation - 5 YR
Dealers and Brokers Pension and Retirement Investment Funds Foreign
80%

70%

60%

50%

40%

30%

20%

10%
TIPS Investor Participation - 20 YR
0%
Individuals Dealers and Brokers Pension and Retirement Investment Funds Foreign
Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08
70%

60%

50%

40%

30%

20%

10%

0%
Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08

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What index does Treasury use to measure inflation?

• The inflation accrual to the principal of TIPS is linked to Consumer Price Index Urban
Non-Seasonally Adjusted (CPI–U NSA) lagged by 3 months.
• The payment of principal at maturity is guaranteed against deflation as measured by
CPI-U NSA lagged 3 months at maturity (a deflation floor).
• What is the CPI-U?
• The CPI-U includes 87% of the US population and includes wage earners and
clerical worker households as well as groups such as professional, managerial, and
technical workers, the self- employed, short-term workers, the unemployed, and
retirees and others not in the labor force. 1
Education and Other Food and
Communication 3% Beverage
6%
15%
Recreation
6%
Medical Care
6%

Transportation
18%

Housing
42%
Apparel
4%
1 Current CPI Basket
Bureau of Labor Statistics
Office of Debt Management
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CPI-U NSA versus Other Common Measures of Inflation
Comparing Different Inflation Measures
10%
CPI-U NSA
Core CPI-U
PPI: Finished SA
8% Core PPI: Finished
PCE SA
Core PCE
6%
Change Year over Year

4%

2%

0%
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
-2%

-4%
Source: BLS/ BEA/ FRB Cleveland / Haver
Office of Debt Management
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Inflation Uncertainty
Distribution of CPI-U NSA since 1950

Beginning Date of Last Observation Included:

June 2007 June 1993 June 1978
12.00%
Median 5th percentile 95th percentile
Error Bars reach to 25th and 75th percentile
10.00%
Annualized Rate of Inflation

8.00%

6.00%

4.00%

2.00%

0.00%
0 5 10 15 20 25 30
Length in Years

Source: BLS / Haver

Office of Debt Management
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Inflation Volatility

Volatility in CPI-U NSA

2.00% 0.030%
MoM Change
Variance over Previous 12-Months
1.50% 0.025%

Variance of MoM Changes in

MoM Change in CPI-U NSA

1.00% 0.020%

Previous Year
0.50% 0.015%

0.00% 0.010%

-0.50% 0.005%

-1.00% 0.000%
Jan-70
Jan-72
Jan-74
Jan-76
Jan-78
Jan-80
Jan-82
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Date
Source: BLS / Haver
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Inflation Seasonality

Average CPI-U NSA - CPI-U SA by decade since 1970

0.50%

0.40%

0.30%
Difference Between Indices

0.20%

0.10%

0.00%
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
-0.10%

-0.20%

-0.30%
70's 80's 90's 2000's
-0.40%

-0.50%
Month

Office of Debt Management

Source: BLS / Haver 13
 14

Oct-08
Jul-08 8
r-0
Apr-08 Ap
20-Year
20-Year

Jan-08 7
-0
ct
Oct-07 O
10-Year

Jul-07 7
r-0
Ap
TIPS Auction Performance (Auction Tails)

10-Year

Apr-07
Jan-07 6
-0
ct
5-Year
Auction Breakeven Inflation

Oct-06 O
5-Year

6
Date of Auction

Jul-06 r-0
Date of Auction

Ap
Apr-06
5
Jan-06 -0
ct
O
Oct-05
5
Jul-05 r-0
Ap
Apr-05
4
Jan-05 -0
ct
O
Oct-04
4
Jul-04 r-0
Ap
Apr-04
3
-0
Jan-04 ct
O
Oct-03
3
Jul-03 r-0
Ap
Apr-03
3.3

3.1

2.9

2.7

2.5

2.3

2.1

1.9

1.7

1.5
8

-2

-4

-6

Tail (Auction Yield -WI, bps) Breakeven Inflation (%)

Jan-09
Oct-08
Oct-08
Jul-08
Jul-08
Apr-08
Apr-08
Auction Results and Metrics

Jan-08
Jan-08
Oct-07
Oct-07
Jul-07
Jul-07
Apr-07
Apr-07
Bid to Cover Ratio at TIPS Auctions

Jan-07

Indirect Bidders in TIPS Auctions

Jan-07
Oct-06
Oct-06

Date of Auction
Jul-06
Jul-06

Date of Auction
Apr-06
Apr-06
Jan-06
Jan-06
20-Year

20-Year
Oct-05
Oct-05
Jul-05
Jul-05

Office of Debt Management

Apr-05 Apr-05

10-Year
Jan-05 Jan-05
10-Year

Oct-04 Oct-04
Jul-04 Jul-04

5-Year
Apr-04 Apr-04
Jan-04 Jan-04

5-Year
Oct-03 Oct-03
Jul-03 Jul-03
Apr-03 Apr-03

80%

70%

60%

50%

40%

30%

20%

10%

0%
Jan-03

2.8

2.6

2.4

2.2

1.8

1.6

1.4

1.2

1
Accepted as % of Competitive Accepted
Bid to Cover Ratio (Bids / Accepted) Indirect Bidders
TIPS correlation to Other Asset Classes for Two Timeframes

Since 2004 Since 1998

Correlation to Lehman TIPS Aggregate Total Return Correlation to Lehman TIPS Aggregate Total Return

Index Daily Monthly Quarterly Index Daily Monthly Quarterly

S&P 500 Total Return -0.28 -0.46 -0.38 S&P 500 Total Return -0.20 -0.25 -0.52

Morgan Stanley (MSCI) REIT Index Total Return -0.19 -0.18 0.22 Morgan Stanley (MSCI) REIT Index Total Return -0.15 0.03 -0.16

Traded Weighted Broad - Dollar -0.13 -0.21 -0.46 Traded Weighted Broad - Dollar -0.13 -0.23 -0.06

Gold 0.17 0.28 0.41 S&P Goldman Sachs Commodity Index Energy Total Return 0.12 0.14 0.09

S&P Goldman Sachs Commodity Index Total Return 0.22 0.07 0.02 Oil 0.12 0.10 0.08

Oil 0.23 0.02 0.02 S&P Goldman Sachs Commodity Index Total Return 0.12 0.16 0.10

S&P Goldman Sachs Commodity Index Energy Total Return 0.23 0.04 0.02 Gold 0.16 0.27 0.11

US Aggregate Lehman Total Return 0.86 0.79 0.88 US Aggregate Lehman Total Return 0.73 0.80 0.83

Nominal Treasury Lehman Total Return 0.88 0.86 0.92 Nominal Treasury Lehman Total Return 0.76 0.83 0.87

Time Frame - Beginning 6/1/2004 5/28/2004 6/30/2004 Time Frame - Beginning 4/15/1998 4/30/1998 12/31/1998

Time Frame - Ending 8/14/2008 7/31/2008 6/30/2008 Time Frame - Ending 8/14/2008 7/31/2008 6/30/2008

Observations 1061 51 17 Observations 2604 124 39

Source: Bloomberg, Lehman

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Case Study: Flow of Payments from a 5-Year TIPS
Assumptions: Annual inflation = 3%; Coupon Rate = 2%;
Size Purchased at Auction = $100,000,000 ; Maturity = 5 Years
Blue = Payment before Inflation adjustment Red = Payment from inflation adjustment

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Tax Treatment

• TIPS are taxed not only on the coupon payment but also on the inflation that accrues to
the principal.
• For Example:
•If Investor A purchases TIPS on January 1 and holds it the entire year, Investor A
will owe taxes on two coupon payments as well as the accrual of inflation to the
principal during that year.
•The following document provides additional information regarding the tax treatment of
TIPS: http://www.treasurydirect.gov/instit/statreg/auctreg/auctreg_gsrintax.pdf

Office of Debt Management

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Appendix - Structure of TIPS

Formula Example
Reference CPI = CPI - U NSA lagged 3 months Calculating Reference CPI
translates to For July 22, 2008
d −1 CPI m −3 = CPI April = 214.823; CPI m − 2 = CPI May = 216.632;
CPI r = CPI m −3 + * (CPI m − 2 − CPI m −3 )
m
Where CPI r = Reference CPI; CPI m −3 = CPI - U NSA 3 months prior; d = 22; m = 31
CPI m − 2 = CPI 2 months prior; using
d = day of the month; d −1
m = days in current month
CPI r = CPI m −3 + * (CPI m − 2 − CPI m −3 )
m
22 − 1
CPI r is the CPI - U NSA of 3 months prior on the 1st of any given month. CPI r = 214.823 + * (216.632 − 214.823)
31
For Example : July 1, 2008 uses April CPI as its reference.
CPI r = 216.048

Otherwise CPI r is the linear interpolation between the CPI - U NSA of

3 months prior and 2 months prior as shown in the equation. Calculating an index ratio
Using the Jan 2018 10 - Year; Cusip = 912828HN3
Index Ratios for adjusting the principal of a TIPS Base CPI = 209.49645
(Coupon Payments = Index Ratio * Principal * Coupon Rate/2)
CPI b = Base CPI = CPI r on Dated Date of issue
Base CPI = Reference CPI on the dated day of original issue.
Dated Date of issue = 1/15/2008
CPI b = Base CPI
CPI r 216.048
Index Ratio =
CPI r Index Ratio on 7/22/2008 = = = 1.03127
CPI b CPI b 209.496

Alternatively, Reference CPIs and Index Ratios are available at

http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm

Office of Debt Management

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Appendix - Glossary of Terms

ΠBid to Cover Рamount of competitive bids received divided by amount of competitive bids
accepted.
ΠTail Рdifference between the when-issued rate of a security and the stop out yield at the time
of auction.
ΠBreakeven Inflation Рrate of inflation which makes a TIPS equivalent in cash flows to a
synthetic nominal security.
ΠIndirect Bidder Рcompetitive bidders bidding through a primary dealer at an auction.
ΠLag Рthe time between two events. In the case of TIPS, the time between the occurrence of
inflation (in the form of CPI-U NSA) and its application the principal of the TIPS security.
ΠAccretion Рexpansion to the value of an asset. In this case accretion is the expansion of the
original principal of a TIPS by CPI-U NSA lagged 3 months.
ΠInterpolation Рconstruction of new data observations between known observations. In the
case of TIPS, CPI-U NSA is only reported monthly. Daily CPI levels are linearly interpolated
from the monthly figures to create daily accrual to the principal of TIPS.
ΠTotal Return Рchange in market price of an asset plus any disbursements (coupon payments,
dividends, etc.) divided by market price at the beginning of the period.

Office of Debt Management

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Appendix - Additional Resources

• U.S. Treasury Office of Debt Management –

www.treas.gov/offices/domestic-finance/debt-management

• FRB Cleveland - www.clevelandfed.org

• FRB New York - www.newyorkfed.org

• Federal Reserve Board - www.federalreserve.gov

• Bureau of Labor Statistics - www.bls.gov

• Bureau of Economic Analysis – www.bea.gov

• TreasuryDirect (Bureau of Public Debt) –

http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm

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