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Inflation Report Sets I Bond’s New Variable Rate At 1.06%

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The March inflation report, just released by the U.S. Bureau of Labor Statistics, locks in the I Bond’s new inflation-adjusted variable rate at 1.06%, down from the current 2.02%.

The new inflation-adjusted rate will go into effect May 1, when the U.S. Treasury will also reset the I Bond’s fixed rate, which is currently 0.2%. That fixed rate is highly likely to drop to 0.0% on May 1.

What does this all mean? It means if you haven’t bought I Bonds up to the Treasury’s purchase cap — $10,000 per person per calendar year — you should do that before May 1 to lock in the 0.2% fixed rate for the life of the bond, plus the 2.02% variable rate for a full six months.

Some I Bond basics:

  • A Series I Savings Bond is a Treasury security that earns interest based on combining a fixed rate and an inflation rate.
  • The fixed rate will never change. So if you buy an I Bond today with a fixed rate of 0.2%, it will continue to have a 0.2% fixed rate for the life of the bond.
  • The inflation-adjusted rate (also called the variable rate) changes each six months to reflect the running rate of non-seasonally adjusted inflation. That rate is currently set at 2.02% annualized. It will adjust again on May 1 for all I Bonds to 1.06%. (The effective start date of the new variable rate depends on the month you bought the I Bond, a Treasury oddity.)
  • The combination of the fixed rate and inflation-adjusted rate creates the I Bond’s composite interest rate, which is currently 2.22%. An I Bond bought today will earn 2.22% (annualized) for six months and then get a new composite rate every six months for its 30-year term. For I Bonds purchased after May 1, the new composite rate will likely be 1.06%, assuming the fixed rate is dropped to 0.0%.

In the just-released inflation report, the BLS set the March non-seasonally adjusted inflation index at 258.115, a decline of 0.22% from the February number. That set the six-month inflation total to 0.53%, resulting in the new variable rate of 1.06%. Here are those numbers:

I Bonds and InflationI Bonds as a short-term investment

I Bonds can’t be redeemed for one year, and from years one to five can be redeemed with a three-month interest penalty. After five years, there is no penalty for redemption.

Even with the interest penalty, an I Bond has potential as a one-year investment, as I noted in a March 30 article. If you buy an I Bond before May 1, you will earn the composite rate of 2.22% for six months, and then a composite rate of 1.26% for six months, creating an annual return of approximately 1.74%, on a par with best-in-the-nation one-year bank CDs.

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I don’t recommend an I Bond as a short-term investment, because the annual purchase cap of $10,000 per person makes it difficult to build a sizable allocation in I Bonds without buying and holding each year.

But under these current terms, an investor in I Bonds can feel confident knowing earnings will be on a par with other safe alternatives. If you need to redeem after a year, no big deal.

Another factor to consider is that the next variable rate reset, on November 1, could fall well below 0.0%, meaning I Bonds purchased today will earn about 1.74% for a year, then 0.0% for six months. If you wait three months of that 0.0% period, you can redeem the I Bond with zero penalty, since three months of 0.0% is 0.0%.

I Bonds as a longer-term investment

Because I Bonds can be redeemed after five years with no penalty, and retain the same fixed rates for up to 30 years, they can be compared with investments in Treasury Inflation-Protected Securities of those maturities. And right now, I Bonds have a huge advantage over TIPS.

  • An I Bond purchased before May 1 will carry a permanent fixed rate of 0.2%, meaning its real yield (yield above inflation) is 0.2%.
  • A 5-year TIPS currently has a real yield of -0.49%, 69 basis points lower.
  • A 10-year TIPS yields 0.50%, 70 basis points lower.
  • A 30-year TIPS yields -0.12%, 32 basis points lower.

I Bonds are the world’s best inflation-protected investment. If you want to allocate part of your portfolio to inflation protection, buy I Bonds first, up to the purchase cap, before investing in TIPS or TIPS mutual funds or ETFs.

And, by the way, the fact that an I Bond could in the future yield 0.0% for six months shouldn’t bother you. Because I Bonds can never have principal balances adjusted downward — as happens with TIPS — I Bonds get a nice bounce-back effect after inflation rebounds to positive. And remember, if the nation suffers deflation of -3.0%, an I Bond earning 0.0% has a real return of 3.0%. This isn’t true with a TIPS.

Conclusion: Buy I Bonds up to the purchase limit before May 1.

The March inflation report

March inflation versus consensusThe Consumer Price Index for All Urban Consumers declined 0.4% in March on a seasonally adjusted basis, the BLS reported. Over the last 12 months, headline inflation increased 1.5%.

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The drop of 0.4% was the largest monthly decline since January 2015, and was lower than the consensus estimate of -0.3%. Core inflation, which strips out food and energy, fell 0.1% in March, below the consensus estimate of 0.1%. Year-over-year core inflation came in at 2.1%, below the estimate of 2.3%.

Sharp declines in gasoline prices — which fell 10.5% in the month — were a major factor in March deflation. But price declines were spread across the economy, with airline fares falling 12.5% in March, and costs of lodging away from home dropping 6.8%. Apparel prices were down 2.0%.

Food-at-home prices, however, increased 0.5% in March. The costs of medical care services were also up 0.5%. The costs of shelter were unchanged.

Here is a rather alarming chart showing the trend of inflation over the last 12 months, with headline inflation taking a sharp drop — primarily based on gasoline prices — and core inflation also dipping, but remaining above 2.0% year-over-year:

one year of inflationEven if gasoline prices begin to rebound higher — and a spike upward appears highly unlikely — deflation is settling in across the economy: Apparel (department stores are closed), new cars (no one is buying), hotels (no one is traveling), restaurants (no one is dining out) and even shelter (rents are going upaid).

We’re in for a rough few months, and the results are impossible to predict.

What the inflation report means for TIPS

The principal balances of TIPS are adjusted upward (and sometimes downward, unfortunately) to reflect monthly non-seasonally adjusted inflation. Because non-seasonally adjusted inflation fell 0.22% in March, principal balances for TIPS will be adjusted downward by 0.22% in May 2020. Here are the new May Inflation Indexes for all TIPS.

What’s ahead for interest rates?

The Federal Reserve has already lowered its Federal Funds rate to the rock bottom range of 0.00% to 0.25%, and I’d expect that rate to stay there for most of 2020. The Treasury market is pricing in low inflation, with the 10-year nominal Treasury yielding 0.73% and a 10-year TIPS with a real yield of -0.50%, resulting in a 10-year inflation breakeven rate of 1.23%.

While 1.23% is low, I’d say it’s within reason and the market is properly pricing in the inflation hedge provided by TIPS. Take a look at this chart of the 10-year inflation breakeven rate so far 2020:

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inflation breakeven rateOn March 19, the 10-year inflation breakeven rate plummeted to 0.50%, a remarkably low number. This was also the day the Treasury auctioned a 10-year TIPS reopening with real yield of 0.68%, much higher than expected. On March 18, the TIP ETF closed at $108.65. All these numbers were indicating a bond market out of sync.

Soon after, the Federal Reserve stepped in to buy Treasurys and stabilize the market. Since March 19:

  • The 10-year inflation breakeven rate has risen from 0.50% to 1.23%, a much more reasonable number.
  • The 10-year TIPS that auctioned with a real yield of 0.68% on March 19 is now trading on the secondary market with a real yield of -0.52%, a drop of 120 basis points. The rise in its market price was about 12.1% — in less than a month.
  • The TIP ETF has risen from $108.65 at the close March 18 to a close of $121.53 on April 9, an increase of 11.8%.


I think the bond market has stabilized at logical levels for this stage of a declining economy. Does that make Treasurys and TIPS attractive? Not really. The time to buy was March 19, when the market was collapsing. The TIP ETF at $121.53 and offering yields negative to inflation is not appealing.

Is inflation dead? Certainly, we are heading toward a period of deflation, countered by massive Federal Reserve stimulus and U.S. government spending. If we come out of this COVID-19 crisis soon, all of that stimulus could prompt a surge in inflation. It has already caused a surge in stock market assets.

So allocating a portion of your portfolio to inflation protection still makes sense.

And if you are interested in inflation protection, my advice is to invest your first $10,000 per person in I Bonds, purchased before the rate reset on May 1.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can purchased through the Treasury or other providers without fees, commissions or carrying charges.

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