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

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 Foreign Series, $3, 0% R.E.A. Series, $0, 0% TIPS, $517, 11% SLGS Series, $266, Domestic Series, $30, Bills, $1,136, 24% 1% 6% Savings Bonds, $195, Bonds, $581, 12% 4% Government Account Office of Debt Management (In billions) (In billions) Series, $4,266, 89% Notes, $2,575, 53% 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 TIPS 1 . • 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 4

Historical TIPS Securities Issuance and Amount Outstanding TIPS Annual Issuance and Outstanding 90 500 30-Year (LHS) 450 20-Year (LHS) 80 10-Year (LHS) 400 70 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 5

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 Office of Debt Management 6

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 7

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 Office of Debt Management 8

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 Bureau of Labor Statistics Current CPI Basket Office of Debt Management 9

10 Jan-08 Jul-07 CPI-U NSA versus Other Common Measures of Inflation Jan-07 Jul-06 Jan-06 Jul-05 Jan-05 Comparing Different Inflation Measures Jul-04 Jan-04 Jul-03 Jan-03 Jul-02 Jan-02 Jul-01 Jan-01 Source: BLS/ BEA/ FRB Cleveland / Haver Core PPI: Finished PPI: Finished SA Jul-00 Core CPI-U Jan-00 CPI-U NSA Core PCE PCE SA Jul-99 Jan-99 Office of Debt Management Jul-98 Jan-98 Jul-97 Jan-97 10% 8% 6% 4% 2% 0% -2% -4% Change Year over Year

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 11

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 Office of Debt Management 12

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 8 Jul-08 0 - r p A Apr-08 20-Year 7 20-Year Jan-08 0 - t c O Oct-07 10-Year 7 Jul-07 0 - r p TIPS Auction Performance (Auction Tails) 10-Year A Apr-07 6 Jan-07 0 - 5-Year t c Auction Breakeven Inflation O Oct-06 5-Year 6 Date of Auction Jul-06 0 - r p Date of Auction A Apr-06 5 0 Jan-06 - t c O Oct-05 5 0 Jul-05 - r p A Apr-05 4 0 Jan-05 - t c O Oct-04 4 0 - Jul-04 r p A Apr-04 3 0 - Jan-04 t c O Oct-03 3 0 - Jul-03 r p A Apr-03 3.3 3.1 2.9 2.7 2.5 2.3 2.1 1.9 1.7 1.5 8 6 4 2 0 -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 Oct-05 20-Year Oct-05 Jul-05 Jul-05 Apr-05 Office of Debt Management Apr-05 Jan-05 10-Year Jan-05 10-Year Oct-04 Oct-04 Jul-04 Jul-04 Apr-04 5-Year 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 3 2.8 2.6 2.4 2.2 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 -0.20 -0.25 -0.52 S&P 500 Total Return -0.28 -0.46 -0.38 -0.19 -0.18 0.22 Morgan Stanley (MSCI) REIT Index Total Return -0.15 0.03 -0.16 Morgan Stanley (MSCI) REIT Index Total Return Traded Weighted Broad - Dollar -0.13 -0.21 -0.46 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 Gold 0.17 0.28 0.41 Oil 0.12 0.10 0.08 S&P Goldman Sachs Commodity Index Total Return 0.22 0.07 0.02 S&P Goldman Sachs Commodity Index Total Return 0.12 0.16 0.10 Oil 0.23 0.02 0.02 Gold 0.16 0.27 0.11 0.23 0.04 0.02 S&P Goldman Sachs Commodity Index Energy Total Return US Aggregate Lehman Total Return 0.73 0.80 0.83 US Aggregate Lehman Total Return 0.86 0.79 0.88 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 2604 124 39 Observations 1061 51 17 Source: Bloomberg, Lehman Office of Debt Management 15