The Treasury's sale of a record $13 billion in 10-year notes on Jan. 20 showed waning demand for inflation-linked debt. The auction received the fewest bids per dollar of the debt sold since April 2009, with a 2.37 bid-to-cover ratio. The previous 10 sales had an average 2.73 ratio. The break-rate fell 14 basis points the next day, the biggest drop since May 20.
TIPS pay interest on a principal amount that rises with consumer prices. Their face value is protected against deflation, because the principal can't fall below par.
U.S. inflation-indexed debt has been a sweet spot for government bond investors, with an average annualized 8.2% gain the past two years, compared with 1% for the whole Treasury market, Merrill Lynch indexes show.
The yield on the 1.25% TIPS maturing in July 2020 rose 13 basis points to 1.06% last week. At the same time, the yield on the 10-year Treasury note jumped 8 basis points to 3.40%, according to BGCantor Market Data.
The TIPS rate was 1.08%, and the 10-year Treasury yielded 3.43% today as of 10:30 a.m. in London.
Record Deficits
TIPS sales are increasing as the government sells record amounts of bonds to fund the federal budget deficit projected to top $1.2 trillion for a third year.
Treasury will auction $120 billion to $125 billion of TIPS in 2011, after boosting issuance by 48% to a record $86 billion last year, according to Barclays Plc and Credit Suisse estimates. The total amount of marketable U.S. debt outstanding increased by 22% to $8.86 trillion in 2010.
Larger sales may attract investors who had avoided the market on concern too few bonds restricted trading and made the debt too risky, said Michael Pond, co-head of interest-rate strategy at Barclays in New York.
"Where we find value is as an inflation insurance play," Pond said. "The Fed is keeping its foot on the accelerator despite the fact that data has been coming in better the past couple of months."