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From BoA Merrill Lynch As we discussed in our 2010 Rates Outlook, we expect strong demand for a 30- year TIPS issue, but the initial auction in February could still be difficult (J. Shatz, “TIPS: Expect higher real yields, higher BEs in 2010”, US Rates Weekly: 2010 Rates Outlook, 2/1/10). For those that recall the initial 20-year TIPS auction in July 2004, there was a substantial tail. Many investors may decide to just bid for a tail or to sit out the first reinstated 30-year auction in February 2010 and possibly buy afterward in the secondary market if the yield is attractive. Most of the July 2004 20-year auction was taken down by a combination of the broker dealer community and investment funds, while foreign participation was relatively light. Foreign central banks generally tend not to be heavy participants in the very long end of the curve. Given that they have been asking for an increase in TIPS supply and that they have recently increased their participation in the 10-year TIPS auction, it will be interesting to see if they increase their participation in the 30- year auction. We suspect that they will be lightly involved in the auction but not to the extent that they are involved in the shorter maturities. The success of the auction could also depend on the size of the auction and where the WI roll is trading at the time. In the case of the 20-year auction in July 2004, the size of the auction was slightly larger than anticipated and the roll was trading rich at the time of the auction, in our view. These both likely contributed to the auction tailing. In terms of where the WI roll initially may come, our initial thoughts are that the new WI 30-year TIPS may come about 2-3bp rich versus the 2.5% 1/15/29 TIPS (current 20-year TIPS). This is primarily the result of a liquidity premium since the real yield curve is relatively flat and the financing component is close to zero. The real yield curve is probably relatively flat in the 20-30 year sector. We obtain this by comparing the 20-30 year zero coupon inflation swap curve to the 20-30 year Treasury zero coupon STRIPS curve, which are both very similar (about 10- 15bp). The 20-30 year nominal Treasury coupon curve is also about 10-15bp. With 20-30 year curves in both nominal yield and inflation space relatively similar, this implies a relatively flat real yield curve. Since the financing component of the roll is also relatively close to zero, this leaves the roll primarily a result of a “benchmark premium” for this new issue as liquidity should shift out of the 20-year sector and into this new liquid 30-year TIPS issue. It’s difficult to determine what this liquidity premium is worth, but we would estimate it is worth 2-4bp.