Tracking inflation and I Bonds: A new data page

I have added a new data page to this site’s top navigation: Tracking Inflation and I Bonds that I will be updating each month when new inflation numbers are released. I have been having a hard time finding this information, so I figured I should compile it myself. Here is the chart that I’ll be updating:

Tracking inflation and I Bonds

Posted in Investing in TIPS | 4 Comments

I Bond scenarios: Counting down to May 1, 2014

Savings-Bond-IIf you haven’t bought US Savings I Bonds up to the limit in 2014, you face an interesting decision: Buy right now, or wait until May 1, when the Treasury will reset the variable interest rate for all I Bonds and determine the fixed rate for bonds sold between May 1 and Oct. 31.

I Bonds pay a combination of two interest rates:

1. The inflation-adjusted rate, also called the variable rate, changes each six months to reflect the running rate of inflation. That rate is currently set at 1.18% annualized. It will adjust again on May 1, 2014, for all I Bonds. The starting date of the new interest rate depends on the month you bough the I Bond. Learn more here.

The Treasury uses the non-seasonally adjusted Consumer Price Index (CPI-U) to set this variable rate. The March inflation number was the last piece of data we needed to know the next variable rate. The inflation index at the end of March was 236.293, a 0.9156% increase over the 234.149 recorded at the end of September 2013. This will mean the new I Bond inflation-adjusted rate will go to an annual rate of 1.83% (or possibly 1.84%, depending on how the Treasury rounds the numbers) for six months beginning May 1.

2. The fixed rate, currently 0.2% for as long as you hold the I Bond, up to 30 years – will never change. So if you bought an I Bond in 2013 with a zero fixed rate, it will continue to have a zero fixed rate. Purchases through April 30, 2014, have a fixed rate of 0.20%.

The Treasury will re-set the fixed rate on May 1 and there is no way to know for sure what it will be, except it won’t be less than 0.0%. When the Treasury set the 0.2% fixed rate on Nov. 1, 2013, it broke a three-year string of 0.0% fixed rates. That was a surprise.

On Nov. 1, 2013, a 10-year TIPS was yielding 0.50%. Today, it is yielding 0.52%, an increase of 2 basis points. That seems like a pretty strong argument for leaving the fixed rate where it is, at 0.20%. But the Treasury is mysterious. Here’s my wild guess:

Fixed Rate on May 1 Percentage chance
0.00% 15.0%
0.10% 15.0%
0.20% 69.9%
Higher than 0.20% 0.1%

I have wondered if the Treasury set the 0.20% fixed rate in November to offset the low inflation-adjusted rate, which was stuck at 1.18% annualized for 12 months. That rate will now be rising to 1.83%; does that eliminate the need to keep the fixed rate at 0.2%?

Because the fixed rate stays with an I Bond through its entire life, up to 30 years, it is a very desirable thing. So let’s get to the scenarios.

Purchase I Bonds before May 1

I am in this group because I bought my I Bond allocation in February ($10,000 per person per year, at Treasury Direct). Buyers can also get $5,000 in paper I Bonds in lieu of a tax refund, but I don’t use this strategy.

  • Fixed rate 0.20%
  • Variable rate 1.18% for six months, 1.83% for six months
  • Combined rate of 1.38% for six months, 2.03% for six months
  • Effective rate of 1.705% for 12 months

Purchase I Bonds between May 1 and Oct. 31

  • Fixed rate unknown
  • Variable rate of 1.83% for six months, unknown for six months
  • Combined rate unknown
  • Effective rate unknown

At lot isn’t known, because to look out a year for an I Bond purchased in May requires a second inflation adjustment on the variable rate, and that number won’t be known until mid-October. If you think inflation will be rising this year, you may want to wait.

If the fixed rate stays at 0.20%, waiting will look like a smart move. You’d get a combined interest rate of 2.03% for six months and bypass the six months at 1.38%. November’s new variable rate is not known, but that’s the same for all I Bond holders.

If the fixed rate drops to 0.0%, you’d still do OK in the first year, with the combined rate of 1.83% for six months. Even if the variable rate dropped to zero in November, you’d get a combined rate of 0.92% for 12 months.

If you plan to sell the I Bond after a year, no big deal. (You’d lose three months of interest, however.) But if you are holding the I Bond for 20 or 30 years, you want the highest possible fixed rate.

Purchase I Bonds between Nov. 1 and Dec. 31

  • Fixed rate unknown
  • Variable rate unknown
  • Combined rate unknown
  • Effective rate unknown

Why would you wait until Nov. 1 and face all these unknowns? You would if you believe interest rates and inflation will be rising in 2014. If that happens, you might get a higher fixed rate and higher variable rate than you could get in April or May.

The rates set in November will be in effect in January, when the I Bond purchase-limit  clock will reset. I will probably be buying again at the beginning of 2015, up to the limit. If rates rise this year, a savvy buyer could double up on the November to April I Bonds by purchasing them in December and then again in January.

Posted in I Bond, Inflation | 7 Comments

5-year TIPS auctions with a yield of -0.213%

The Treasury just announced that a new 5-year TIPS, CUSIP 912828C99, auctioned with a yield to maturity of -0.213% and a coupon rate of 01.25%. The combination of negative yield and positive coupon rate means that buyers paid an adjusted price of $101.87 for $100 of value, which includes about 5 cents of inflation adjustment through April 30.

Read the announcement.

The yield of -0.213% continued a string of 11 consecutive 4- to 5-year TIPS auctions that produced a yield negative to inflation. Because the principal balance of a TIPS grows with inflation, buyers today accepted a return 0.123% less than inflation over the next five years.

When you look at the 5-year inflation breakeven rate, you can see why some buyers would find this issue attractive. A 5-year nominal Treasury is trading right now at 1.70%,  setting up an inflation breakeven rate of 1.91%, meaning that this TIPS will outperform a traditional Treasury if inflation averages more than 1.91% over five years.

Even if this 5-year TIPS under-performs, it probably won’t be by much, so TIPS buyers aren’t giving up much yield to get the inflation protection.

TIP ETFTwo weeks ago, this TIPS looked likely to carry a positive yield, but Treasurys  strengthened as the stock market weakened and turmoil rose again in Ukraine. The TIP ETF was up strongly in the minutes after the auction closed, indicating a positive reaction to the auction.

At 11:14 a.m., before the auction closed, Bloomberg forecast a yield of -01.62%, based on a survey of primary dealers.

So it looks like the Treasury is the winner in today’s auction.

Reaction to the auction

The Wall Street Journal’s Cynthia Lin noted ‘a strong turnout’ for this auction, noting that the yield of 0.213% was less than the market rate at the time of the sale,  “reflecting strong demand.”

Bloomberg’s Cordell Eddings noted strong demand from overseas buyers, which include central banks.

The bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, was 2.7, matching the highest level since December 2012. “The stats were off the charts,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., a primary dealer.



Posted in Investing in TIPS | 1 Comment

Checking in on today’s 5-year TIPS auction — note earlier bid times

The U.S. Treasury will announce results of its auction of a new 5-year Treasury Inflation-Protected Security, CUSIP 912828C99, just after 11:30 a.m. Non-competitive bids have to be placed by 11 a.m., if you are buying at TreasuryDirect. The times are earlier for this auction because of the Easter weekend.

What to expect. This TIPS has been a hard one to call, with possible yields falling all over the place. A few weeks ago, it looked like this TIPS would generate a positive yield to maturity (plus inflation), but that looks unlikely now. The coupon rate will almost certainly be 0.125%, the same rate for the last nine 4-to 5-year TIPS auctions, because that is the lowest coupon rate the Treasury allows on TIPS.

Combine a negative yield at auction with a coupon rate of 0.125% and you get an above-par price for buyers at today’s auction, possibly $102 or more for $100 of value.

  • The Treasury’s chart of Daily Treasury Real Yield Curve Rates is currently showing a 5-year TIPS yielding -0.06%. This is usually my preferred source for new issues, but the number looks a little suspect because …
  • Bloomberg’s Current Yields chart this morning is showing a yield of -0.50% for the newest 5-year TIPS currently trading. But this TIPS was issued a year ago, so it is actually a 4-year TIPS and that skews the number. You’d expect a shorter-maturity TIPS to yield less, especially in a time of very low inflation.
  • The Wall Street Journal’s closing prices chart shows TIPS bracketing the maturity date of this new TIPS yielding -0.401% and -0.365%, and you have to go out to a maturity of July 2020 to find a yield of -0.118%

So, at this point, the Treasury seems to be predicting one number (-0.06%) and the market points to another (maybe around -0.385%). That’s a 32-basis point swing – an unusual amount of uncertainty.

The 5-year nominal Treasury closed Wednesday at 1.67%, setting up a 5-year inflation breakeven point of 1.73% (if you trust Treasury’s low prediction) or 2.05% (if you trust the market numbers).

If this TIPS goes off with a yield of -0.06%, it will be a pretty good bargain for buyers. We’ll see what happens at 11:30 a.m.

Posted in Investing in TIPS | 2 Comments

U.S. inflation rose 0.2% in March, what does this mean for I Bonds?

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in March on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported this morning. This was slightly higher than the expected rate of 0.1%, and resulted in an inflation rate of 1.5% over the last 12 months.

Increases in the shelter and food indexes accounted for most of the increase. The food index increased 0.4% in March, with several major grocery. The energy index, in contrast, declined slightly in March, with gasoline down 1.7% and fuel oil down 2.9%. Utility gas service was up a strong 7.5%.

Excluding the volatile food and energy categories, core prices increased 0.2& in March and 1.7% in the past year.

Holders of TIPS and I Bonds are also interested in the non-seasonally adjusted CPI-U, which is used to determine the inflation adjustment on TIPS and the future inflation-adjusted interest rate on I Bonds. This number was up 0.6% in March, but the number for the last 12 months remains at 1.5%.

What this means for I Bonds. The March inflation number was the last piece needed to determine the inflation-adjusted variable rate for I Bonds that will begin May 1.

The inflation index at the end of March was 236.293, a 0.9156% increase over the 234.149 recorded at the end of September 2013. This should mean that the new I Bond inflation-adjusted rate will go to an annual rate of 1.83% or 1.84% for six months beginning May 1.

The annualized rate is currently 1.18%, plus a fixed rate of 0.2% that lasts as long as you hold the I Bond. We don’t know if the Treasury on May 1 will keep the fixed rate at 0.2%, drop it, or raise it. The Treasury does not provide a formula on how it makes this decision.

Posted in I Bond, Inflation, Investing in TIPS | Leave a comment

Next up: 5-year TIPS auctions April 17, 2014

What was looking like a fairly attractive auction of a new 5-year Treasury Inflation-Protected Security has lost a little of its luster in the last week, but this one is still worth a look. The Treasury announced Thursday it will auction CUSIP 912828C99 on April 17, 2014, with the coupon rate and yield to maturity to be set at auction.

What can we expect? The coupon rate will almost certainly be 0.125%, the same rate for the last nine 4-to 5-year TIPS auctions. That streak was set because 4- to 5-year TIPS have been yielding negative to inflation almost every day since late September 2010. The lowest coupon rate the Treasury will set on a TIPS is 0.125%, and that means buyers have to ‘pay up’ when an auction results in a negative yield.

According to the Treasury’s Daily Yield Curve tables, a 5-year TIPS is currently yielding -0.10%, down from year-to-date high of 0.11% set on April 3. So the yield has dropped 21 basis points in a eight days – not a good trend heading into an auction.

Why the drop in yield? This one is a ‘flight to safety’ — Treasurys always benefit when the stock market is in turmoil. A nominal 5-year Treasury is yielding 1.59%, down 21 basis points in nine days. During that same time, the S&P 500 stock index is down 3.03%.

Stocks versus TIPSWhy is the stock market weakening? Could it be that it has had a remarkable run-up for more than five years and some high-risk stocks were getting very bubbly? Could be, but I have no idea what drives the stock market and if this trend will continue.

If it does continue, though, we can forecast that we are in for a short-term decline in TIPS yields heading into next Thursday’s auction.

Looking for yield. At the beginning of April, it looked like we would get a 5-year TIPS auction with a positive yield, and that would have been worth a celebration. It’s been four years since we’ve seen that. At the least, it would have meant buyers would get a 5-year TIPS at around par. That doesn’t look likely now. Buyers can expect to pay $101.50 to 102.00, at least, for $100 of value at next week’s auction.

And it isn’t a good thing that a TIPS maturing 2019 Jul 15 is currently trading at -0.387%.

If this TIPS does go off at -0.10%, it would be the highest yield for any 4- to 5-year TIPS in four years, since an April 2010 auction netted a yield of 0.55%. But it looks more likely that the recent high of -0.127%, set in August 2013, will hold until the next reissue. I was a buyer at that auction, but I will probably pass on this one.

Here are the numbers for recent 4- to 5-year TIPS auctions:

5 year TIPSThe I Bond alternative. I Bonds are currently paying a fixed rate of 0.2% plus inflation and can be sold after five years with no penalty. Plus, federal taxes are deferred until you sell the I Bond. Clearly, I Bonds are a better investment than a 5-year TIPS.

If you haven’t bought I Bonds this year, you are probably holding out to see where the fixed rate is headed in the May 1 adjustment. If you absolutely, for certain want to lock in the 0.2% fixed rate, you need to buy before May 1. If you think the fixed rate will be going up, you should hold off buying until after May 1.

With a 10-year TIPS currently yielding 0.51%, I can’t see the Treasury raising the fixed rate higher than 0.2%. And with inflation running at extremely low levels, the Treasury could kill demand for I Bonds if it lowers the fixed rate back to 0.0%, where it was for several years.

So my wild guess is that the fixed rate will remain at 0.2%. The Treasury can sometimes surprise you though – like it did last November when it raised the fixed rate to 0.2% for no apparent reason.

By the way, I bought my I Bond allocation back in February. I’m not much of gambler.

Posted in I Bond, Investing in TIPS, Savings Bond | Tagged , , , | 8 Comments

When the Fed begins raising rates, what will happen to TIPS?

Janet Yellen, the Federal Reserve chair, set off a lot of turmoil in the markets on March 19  by hinting that the federal funds rate – which sets a base for short-term interest rates – could begin rising ‘around six months, that type of thing‘ after the Fed’s bond-buying program ends later this year.

That comment, at a news conference, sent the bond and stock markets into a tizzy. Yellen’s off-the-cuff comment implied that rates could begin rising in mid 2015 instead of  late 2015 early 2016, as the markets expected.

Since then, Yellen and the Fed have backed off, saying there is no timetable for increases in the federal funds rate. But the Federal Reserve itself is forecasting that its benchmark rate – now close to zero – will rise at least to 1% at the end of 2015 and to 2.25% by the end of 2016.

So let’s assume that the federal funds rate does rise to 2.25% at the end of 2016. How will that affect the prices and yields of Treasury Inflation-Protected Securities?

fed funds historyNo surprise. Rates are going up. No one can say this for certain, of course, and it depends on three things happening: 1) the U.S. economy must continue to improve, 2) the inflation rate must reach or at least approach the target level of 2%, and 3) the Federal Reserve must have the courage to raise rates when 1 and 2 are achieved.

But if these three things happen – and this is the most likely scenario, in my opinion – we will see the federal funds rate at 2.25% at the end of 2016 (or earlier), and we will see yields rise for both nominal Treasurys and TIPS.

So let’s take a look at the history of the federal funds rate; I have included some numbers from the past in the chart at the right. If you want to see the data, check out this site. What you will find is that 2.25% is a historically low rate. Today’s ultra-low fed rate – at a time when the stock market is hitting all-time highs – looks as out of place as that 20.06% number from January 1981.

So, the point is, there would be nothing extraordinary about a 2.25% fed rate, and in fact, it historically would have been a rate meant to spur economic growth, not deter it.

My next step was to look at times when the fed rate stood at 2.25% and cross-check the then-current yields for nominal Treasurys and TIPS. Here is what I found when I did the calculations on March 27:

Compare fed rateYes, the data are limited for several reasons: 1) TIPS have been in existence only since 1997, 2) a federal funds rate of 2.25% is relatively rare and 3) 30-year TIPS auctions were halted from October 2011 to February 2010, so there are no comparable data for 30-year TIPS.

But using these numbers as guidelines, I think we can make predictions about where interest rates are headed (not precisely, but an estimate) when the fed funds rate reaches 2.25%. I am using the average of each range to determine these numbers:

  • 5-year Treasury yields will increase 149 basis points
  • 5-year TIPS yields will rise 82 basis points
  • 10-year Treasury yields will rise 120 basis points
  • 10-year TIPS yields will rise 97 basis points
  • 30-year Treasury yields will rise 82 basis points
  • 30-year TIPS yields will rise an undetermined amount

Continuing on with this premise, let’s say the 10-year TIPS yield rises 97 basis points by the end of 2016, reaching a level of 1.53%. That’s perfectly reasonable by historical standards (probably even conservative), and it would equate to a 10-year nominal Treasury rate of 3.89%, creating an inflation breakeven point of 2.36%, also perfectly reasonable.

This sort of rise – 97 basis points – is definitely possible. In fact, we saw that happen in less than three months in 2013, when the 10-year TIPS yield rose from -0.74% on April 5 to 0.29% in June 19, a rise of 103 basis points.

What does this mean? If you are invested in a diversified TIPS mutual fund and this scenario plays out, you are going to see a drop in net asset value of about 8%. At the same time, you would benefit from a higher yield in the future.

The TIP ETF, which invests in a broad range of maturities, has a duration of 7.65, meaning its net asset value should decline by 7.65% when yields rise 100 basis points. That played out just as predicted during the 103 basis point rise in the 10-year TIPS from April 5, 2013 to June 19, 2013:

2013 tips decline

Looking into the future. The TIP ETF currently trades at $111.67, up about 1% so far this year. If it took an 8% hit, its net asset value would drop to $102.75, about where it was trading on Oct. 5, 2009, when a 10-year TIPS was yielding 1.51%.

I repeat: Perfectly reasonable. Will this happen? Who knows? But no one should be surprised if it does.

Posted in Investing in TIPS | 10 Comments