[PPT] - Treasury Inflation-Protected Securities (TIPS) Office of Debt PowerPoint Presentation

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Treasury Inflation-Protected Securities (TIPS)

Office of Debt Management U.S. Treasury Department August 2008

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Office of Debt Management

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.

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Office of Debt Management

TIPS Component of the Treasury Debt Portfolio as of July 31, 2008

$9.6 Trillion in Debt Outstanding

Government Account Series, $4,266, 45% Bills, $1,136, 12% Notes, $2,575, 27% Bonds, $581, 6% TIPS, $517, 5% Savings Bonds, $195, 2% SLGS Series, $266, 3%

$4.8 Trillion in Marketable Debt Outstanding

TIPS, $517, 11% Bonds, $581, 12% Notes, $2,575, 53% Bills, $1,136, 24%

$4.8 Trillion in Non-Marketable Debt Outstanding

Government Account Series, $4,266, 89% Savings Bonds, $195, 4% R.E.A. Series, $0, 0% Foreign Series, $3, 0% Domestic Series, $30, 1% SLGS Series, $266, 6%

(In billions) (In billions) (In billions)

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Office of Debt Management

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.

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Office of Debt Management

Historical TIPS Securities Issuance and Amount Outstanding

TIPS Annual Issuance and Outstanding

10 20 30 40 50 60 70 80 90 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Calendar Year $ billions 50 100 150 200 250 300 350 400 450 500 $ billions 30-Year (LHS) 20-Year (LHS) 10-Year (LHS) 5-Year (LHS) Inflation-Adjusted Outstanding (RHS)

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Office of Debt Management

Primary Dealer Trading Activity in TIPS

Source: Federal Reserve Bank of New York

Average Daily Transactions in TIPS by Primary Dealers

$ $2 $4 $6 $8 $10 $12 $14 $16 $18 $20 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 Week Transactions in Billions of $

Average Daily Transactions (LHS)

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Office of Debt Management

Participation in 10-Year TIPS Auctions by Investor Class

TIPS Investor Participation - 10 YR

0% 10% 20% 30% 40% 50% 60% 70% 80% 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 Depository Institutions Individuals Dealers and Brokers Pension and Retirement Investment Funds Foreign

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Office of Debt Management

Participation in 5- and 20-Year TIPS Auctions by Investor Class

TIPS Investor Participation - 5 YR

0% 10% 20% 30% 40% 50% 60% 70% 80% Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Dealers and Brokers Pension and Retirement Investment Funds Foreign

TIPS Investor Participation - 20 YR

0% 10% 20% 30% 40% 50% 60% 70% Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Individuals Dealers and Brokers Pension and Retirement Investment Funds Foreign

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Office of Debt Management

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

Current CPI Basket

Food and Beverage 15% Housing 42% Apparel 4% Transportation 18% Medical Care 6% Recreation 6% Education and Communication 6% Other 3% 1 Bureau of Labor Statistics

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Office of Debt Management

CPI-U NSA versus Other Common Measures of Inflation

Source: BLS/ BEA/ FRB Cleveland / Haver

Comparing Different Inflation Measures

4%
2%

0% 2% 4% 6% 8% 10% 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 Change Year over Year

CPI-U NSA Core CPI-U PPI: Finished SA Core PPI: Finished PCE SA Core PCE

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Office of Debt Management

Inflation Uncertainty

Source: BLS / Haver

Distribution of CPI-U NSA since 1950

0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 5 10 15 20 25 30 Length in Years Annualized Rate of Inflation Median 5th percentile 95th percentile Error Bars reach to 25th and 75th percentile Beginning Date of Last Observation Included: June 2007 June 1978 June 1993

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Office of Debt Management

Inflation Volatility

Source: BLS / Haver

Volatility in CPI-U NSA

1.00%
0.50%

0.00% 0.50% 1.00% 1.50% 2.00% 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 MoM Change in CPI-U NSA 0.000% 0.005% 0.010% 0.015% 0.020% 0.025% 0.030% Variance of MoM Changes in Previous Year MoM Change Variance over Previous 12-Months

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Office of Debt Management

Inflation Seasonality

Source: BLS / Haver Average CPI-U NSA - CPI-U SA by decade since 1970

0.50%
0.40%
0.30%
0.20%
0.10%

0.00% 0.10% 0.20% 0.30% 0.40% 0.50% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month Difference Between Indices

70's 80's 90's 2000's

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Office of Debt Management

Auction Results and Metrics

Bid to Cover Ratio at TIPS Auctions

1 1.2 1.4 1.6 1.8 2 2.2 2.4 2.6 2.8 3 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Date of Auction Bid to Cover Ratio (Bids / Accepted)

5-Year 10-Year 20-Year

Indirect Bidders in TIPS Auctions

0% 10% 20% 30% 40% 50% 60% 70% 80% Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Date of Auction Indirect Bidders Accepted as % of Competitive Accepted 5-Year 10-Year 20-Year

Auction Breakeven Inflation

1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9 3.1 3.3 A p r

3

O c t

3

A p r

4

O c t

4

A p r

5

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5

A p r

6

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6

A p r

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A p r

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Date of Auction Breakeven Inflation (%) 5-Year 10-Year 20-Year

TIPS Auction Performance (Auction Tails)

6
4
2

2 4 6 8 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Date of Auction Tail (Auction Yield -WI, bps) 5-Year 10-Year 20-Year

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Office of Debt Management

TIPS correlation to Other Asset Classes for Two Timeframes

Source: Bloomberg, Lehman

Correlation to Lehman TIPS Aggregate Total Return Index Daily Monthly Quarterly S&P 500 Total Return

0.28
0.46
0.38

Morgan Stanley (MSCI) REIT Index Total Return

0.19
0.18

0.22 Traded Weighted Broad - Dollar

0.13
0.21
0.46

Gold 0.17 0.28 0.41 S&P Goldman Sachs Commodity Index Total Return 0.22 0.07 0.02 Oil 0.23 0.02 0.02 S&P Goldman Sachs Commodity Index Energy Total Return 0.23 0.04 0.02 US Aggregate Lehman Total Return 0.86 0.79 0.88 Nominal Treasury Lehman Total Return 0.88 0.86 0.92 Time Frame - Beginning 6/1/2004 5/28/2004 6/30/2004 Time Frame - Ending 8/14/2008 7/31/2008 6/30/2008 Observations 1061 51 17 Correlation to Lehman TIPS Aggregate Total Return Index Daily Monthly Quarterly S&P 500 Total Return

0.20
0.25
0.52

Morgan Stanley (MSCI) REIT Index Total Return

0.15

0.03

0.16

Traded Weighted Broad - Dollar

0.13
0.23
0.06

S&P Goldman Sachs Commodity Index Energy Total Return 0.12 0.14 0.09 Oil 0.12 0.10 0.08 S&P Goldman Sachs Commodity Index Total Return 0.12 0.16 0.10 Gold 0.16 0.27 0.11 US Aggregate Lehman Total Return 0.73 0.80 0.83 Nominal Treasury Lehman Total Return 0.76 0.83 0.87 Time Frame - Beginning 4/15/1998 4/30/1998 12/31/1998 Time Frame - Ending 8/14/2008 7/31/2008 6/30/2008 Observations 2604 124 39

Since 2004 Since 1998

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Office of Debt Management

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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Office of Debt Management

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

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Office of Debt Management

Appendix - Structure of TIPS

b r b r r m m r m m m r

CPI CPI CPI CPI CPI CPI CPI CPI CPI CPI m d CPI CPI = = = = = = = = = − − + = =

− − − − −

Ratio Index CPI Base issue.

riginal
f

day dated

n the

CPI Reference CPI Base Rate/2) Coupon * Principal * Ratio Index Payments (Coupon TIPS a

f

principal the adjusting for Ratios Index equation. in the shown as prior months 2 and prior months 3

f

NSA U

CPI

e between th ion interpolat linear the is Otherwise reference. its as CPI April uses 2008 1, July : Example For month. given any

f

1st

n the

prior months 3

f

NSA U

CPI

the is month current in days m month; the

f

day d prior; months 2 CPI prior; months 3 NSA U

CPI

CPI; Reference Where ) ( * 1 to translates months 3 lagged NSA U

CPI

CPI Reference

2 3 3 2 3

Alternatively, Reference CPIs and Index Ratios are available at http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm

03127 . 1 496 . 209 048 . 216 7/22/2008

n

Ratio Index 1/15/2008 issue

f

Date Dated issue

f

Date Dated

n

CPI Base 49645 . 09 2 CPI Base 912828HN3 Cusip Year;

10

2018 Jan the Using ratio index an g Calculatin 048 . 216 ) 823 . 214 632 . 216 ( * 31 1 22 823 . 214 ) ( * 1 using 31 m ; 22 d 216.632; 214.823; 2008 22, July For CPI Reference g Calculatin

3 2 3 2 3

= = = = = = = = = − − + = − − + = = = = = = =

− − − − − b r r b r r m m m r May m April m

CPI CPI CPI CPI CPI CPI CPI CPI m d CPI CPI CPI CPI CPI CPI

Formula Example

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Office of Debt Management

Appendix - Glossary of Terms

Bid to Cover – amount of competitive bids received divided by amount of competitive bids

accepted.

Tail – difference between the when-issued rate of a security and the stop out yield at the time
f auction.
Breakeven Inflation – rate of inflation which makes a TIPS equivalent in cash flows to a

synthetic nominal security.

Indirect Bidder – competitive bidders bidding through a primary dealer at an auction.
Lag – the 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.

Accretion – expansion to the value of an asset. In this case accretion is the expansion of the
riginal principal of a TIPS by CPI-U NSA lagged 3 months.
Interpolation – construction 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.

Total Return – change in market price of an asset plus any disbursements (coupon payments,

dividends, etc.) divided by market price at the beginning of the period.

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Office of Debt Management

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) –