September inflation rises 0.1%; new I Bond variable rate will be 1.48%

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1% in September on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, CPI-U (also called ‘headline’ inflation) was up 1.7%.

The September report provided the final piece of data needed to learn the new inflation-adjusted interest rate paid by US Savings I Bonds. The new variable rate – which goes into effect on Nov. 1 – is based on non-seasonally adjusted inflation from March to September 2014.

In March, the CPI-U index stood at 236.293, rising to 238.031 in September. This is a six-month inflation rate of 0.74%, so the new variable rate (annualized) will be 1.48%. I have updated my Tracking Inflation and I Bonds page to reflect these new numbers.

All I Bond holders will eventually get this variable rate for six months, but the date it begins will vary based on the month the I Bonds were issued. Potential I Bond investors can decide to buy before Nov. 1, however, and lock in the current 1.84% variable rate for the first six months, along with the current 0.1% fixed rate for the life of the I Bond.

We don’t know what the Treasury will decide on the fixed rate in November. I have speculated that it will either hold at 0.1% or drop to 0.0%. An increase looks highly unlikely.

In addition, September’s inflation report set the 2015 cost-of-living increase for 70 million Social Security recipients at 1.7%, the third year in a row the increase will be less than 2%.

The inflation report

The BLS reported strong declines in the price of gasoline (-1.0%) and fuel oil (-2.1%), but these declines were balanced off by increases in the costs of food (0.3%), medical care commodities (0.5%) and shelter (0.3%).

The September report again reflects very mild inflation, which has increased just 1.7% over the last 12 months. This is below the Federal Reserve’s target number of 2.0% and danger level of 2.5%, although the Fed uses a different index.

‘Core inflation,’ which strips out food and energy, also rose 0.1% in September and was up 1.7% over the last 12 months.

This chart shows how inflation has eased since the spring of 2014, essentially rising 0.0% over the last three months:

12 month

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I Bond watchers: Important inflation report coming Wednesday at 8:30 a.m.

The US Bureau of Labor Statistics will release the September inflation report Wednesday morning, and this is the final piece of data needed to determine the inflation-adjusted interest rate for US Savings I Bonds from Nov. 1, 2014, to April 30, 2015.

I record these inflation numbers on my Tracking Inflation and I Bonds page. The new I Bond inflation-adjusted rate will be determined by the May to September increase in the Consumer Price Index for All Urban Consumers, otherwise known as CPI-U or ‘headline inflation’ in the media. The one twist from the media reports, though, is that TIPS and I Bonds use non-seasonally-adjusted inflation as the measurement. The index stood at 236.293 in May 2014 and rose to 237.852 in August (although it has declined for two consecutive months).

If you look at my Tracking Inflation page, you can see that inflation from May to August rose 0.66%. If inflation came in at zero for September, the new I Bond variable rate would be set at 1.32% (annualized) for six months. So once we see the September number at 8:30 a.m. Wednesday, we’ll know the variable rate for the next six months.

I Bonds At a GlanceHowever … I Bonds are an odd investment because if you invest in I Bonds between now and Oct. 31, you will receive a fixed rate of 0.1% and a variable rate of 1.84% for six months and then you will receive the new variable rate for the next six months.

(Take a look at the chart to the right. It says I Bonds pay 1.94% through Oct. 31. That is the combination of the 0.1% fixed rate and the 1.84% variable rate, but if you buy before Nov. 1, you get that combo rate for the first six months. Get it?)

So if Wednesday’s inflation number comes in very low or negative, it might be smart to buy your 2014 allocation of I Bonds before Nov. 1 to lock in that higher variable interest rate for the first six months.

The other interesting thing about I Bonds is that the Treasury acts in total mystery when it sets the ‘fixed’ rate, which is currently 0.1% and never changes once you purchase the I Bond. We know nothing about the process the Treasury uses to determine this rate. However, my general guess is that the fixed rate tends to lag 70 to 100 basis points below the yield of a 10-year TIPS. See this chart.

A 10-year TIPS is yielding 0.28% today, so I would say there is a pretty good probability that the Treasury will lower the I Bond fixed rate to 0.0%, where it was from November 2010 to October 2013. But then again, the Treasury shocked everyone when it increased the fixed rate to 0.2% in November 2013, even with the 1o-year TIPS yield at just 0.40%. Six months later, the fixed rate dropped to 0.1% when the 10-year TIPS was yielding 0.49% … go figure.

My guess is that the Treasury either: 1) drops the fixed rate to 0.0% or 2) keeps it at 0.1% and there’s a near-zero chance of it increasing.

Purchase limits. I bought my 2014 allocation of I Bonds in February (and got the 0.2% fixed rate, which lasts the 30-year life of the I Bond). The Treasury allows individuals to buy $10,000 a year at, and an additional $5,000 in paper I Bonds issued as an income tax refund.

If you haven’t purchased your 2014 limit yet, you’ll have an interesting decision to make once the variable rate is set on Wednesday. Buy now or buy after Nov. 1? But you won’t know the new fixed rate until Nov. 1.

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Up next: 30-year TIPS reopens at auction Oct. 23, 2014

Treasury logoThe US Treasury formally announced yesterday that it will reopen CUSIP 912810RF7 on Thursday, Oct. 23, creating a 29-year 4-month Treasury Inflation-Protected Security with a coupon rate of of 1.375%.

This TIPS initially auctioned on Feb. 20, 2014, with a yield to maturity of 1.495%. It reopened on June 19, 2014, with a yield of 1.116%, meaning buyers had to pay $108.34 for $100 of value to collect that coupon rate of 1.375%.

A lot has happened in the TIPS market in 2014. It’s been a roller-coaster ride, with the 30-year TIPS yield starting the year on Jan. 2 at 1.58% (the highest yield of 2014), declining to 0.98% on May 28, rising to 1.17% on June 10, falling to a 2014-low of 0.82% on Aug. 28, rising to 1.17% on Sept. 18, and closing yesterday at 0.89%.

What those numbers mean. CUSIP 912810RF7 is going to be expensive. Buyers at Thursday’s auction may be paying a nearly 13% premium to collect a coupon rate of 1.375%. In other words, $10,000 of this TIPS will cost a buyer $11,300. At maturity 29 years from now, the buyer will get back $10,000, plus inflation, while collecting $137.50 a year in interest (which will also rise with inflation).

This TIPS seems very risky as a trading vehicle, because an uptick in interest rates will send its market value plummeting. It only makes sense as a buy-and-hold investment, and a buyer is going to have to live 29 years, 4 months to get a return.

Let’s look at the current market for CUSIP 912810RF7:

  • Bloomberg’s Current Values chart shows it trading today at 0.89% with a price of about $112.40 per $100 of value.
  • The Wall Street Journal’s Closing Values chart shows that it ended Thursday with a yield of 0.865% and a price of about $112.72.
  • The Treasury’s Real Yields chart, which estimates the yield of a full-term 30-year TIPS, sets yesterday’s close at 0.89%

A lot can happen in a week, especially with the stock market showing plenty of volatility this month. But it’s not likely that this TIPS, which is currently trading just 7 basis points above its low for 2014, which get a lot cheaper before next Thursday.

One interesting factor in Oct. 2014, however, is the dramatic fall in inflation breakeven rates across all TIPS maturities. With a nominal 30-year Treasury yielding 2.94%, we’re looking at a 30-year inflation breakeven rate of just 2.05% – very low. That means this TIPS is actually a pretty good buy against a traditional Treasury.

30-year breakeven

What are the chances that inflation will average less than 2.05% over the next 30 years? It could happen, sure, but take a look at this chart of historical inflation ranges. Going back to 1961, the lowest 30-year inflation rate average was 2.8%, for the 30-year period ending in 2013.

Nevertheless, if I were in the market for a 30-year TIPS – which I am not – I probably would wait until the February 2015 auction of a new issue, when the yield and coupon rate will be aligned – lowering my upfront cost on a very long-term investment.

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PenFed bumps up interest on longer-term CDs (finally)

In a Sept. 11 post, I noted the screwed up state of interest rates on super-safe investments. My evidence was an offering from the Pentagon Federal Credit Union of a 1-year insured  CD, paying 1.06% with just a $1,000 minimum investment.

Pretty good, but the problem was that PenFed’s 2- and 3-year CD rates dropped to 1.05% and the 5- and 7-year CDs were paying a measly 1.21%.

PenFedRidiculous, I noted. But now PenFed has attempted to repair that problem by upping its rates to more attractive levels, at least for 5- and 7-year CDs. These new rates are logical and competitive nationally.

According to, the national average for a 5-year CD is 1.87%, but you can find higher, such as:

  • 2.30% at Synchrony Bank
  • 2.53% at Chartway Federal Credit Union
  • 2.25% at Barclays
  • 2.25% at GE Capital Bank

My hometown credit union, Truliant, is paying just 1.40% for a 5-year CD with a minimal deposit. It shows how important it is to shop around when you have a CD maturing.

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TIPS are rallying (sort of) as stocks wobble

A 10-year TIPS is yielding 0.34% (plus inflation) today on the secondary market, a drop of 27 basis points since the last auction Sept. 18, which resulted in a yield of 0.61%.

That’s a pretty big turnaround for TIPS. The chart below shows three months of price changes for the TIP ETF, which hold a broad range of maturities, versus the SPY ETF, which hold the S&P 500 stocks. The turnaround began on Sept. 18 – the very day of the 10-year TIPS reopening – when the yield reached its highest point in five months. That is also the day that the S&P 500 hit its three-month high.

TIPS versus stocksThe TIP ETF is down slightly today, trading at $113.51 at mid-afternoon, on a day that the stock market is faring very badly. The S%P 500 is down about 1.7%.

So TIPS are benefiting from a flight to safety, but not as much as might be expected. The reason? The market is pricing in very low future inflation, and that is putting a cap on demand for TIPS.

At yesterday’s close, a traditional 10-year Treasury was yielding 2.35%, according the US Treasury daily estimate. A 10-year TIPS was yielding 0.39%, creating a 10-year inflation breakeven rate of 1.96%. So a 10-year TIPS will outperform a 10-year Treasury if inflation runs higher than 1.96% over the next 10 years. That is a low breakeven rate, and it indicates demand for TIPS hasn’t really increased much as the stock market has declined.

Here is a chart of 10-year breakeven rates since January 2012, and it demonstrates the very steep and very fast decline in inflation expectations:

break evenMy general feeling is that TIPS are attractive – at least versus traditional Treasurys – when the breakeven rate drops below 2%, as it has now. But yields have also dropped in recent weeks, making TIPS a little less attractive overall.



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Chart of the day: Stocks versus TIPS over the last month

Back on Sept. 4 I posted ‘Why TIPS aren’t a good buy right now: A story in charts‘, in which tried to explain why the TIPS market looked a little out-of-whack, with TIPS yields dropping too low (and TIPS prices rising too high) against similar investments.

A LOT has happened since Sept. 4: 1) A weak inflation report, 2) the Federal Reserve hinting at higher interest rates possible by the end of next year, 3) a weak 10-year TIPS auction on Sept. 18, 4) a rise in Treasury yields and 5) a modest drop in the U.S. stock market.

No. 5 is especially interesting because Treasurys usually run counter to the stock market, especially during a strong decline. When stocks suddenly drop, fear rises and that usually pushes up demand for Treasurys, and results in lower yields.

So here is a comparison of how stocks (represented by the Standard and Poors 500 ETF) have performed over the last month versus TIPS (represented by the TIP ETF):

Stocks TIPS SeptemberRemarkably, the overall performance has been very similar (down about 2% in a month), but the paths are pretty different. TIPS have gotten a small bump in the last few days as stocks dropped sharply. In fact, today’s trading, which isn’t reflected in that chart, has the TIP ETF down anther 0.5% and SPY is trading up 0.65%.

Inflation breakevens have been dropping. Investors seem to be signalling lower fear of future inflation, and that creates less demand for TIPS.  Right now, according to Bloomberg’s Current Yields, a 10-year Treasury is trading at 2.53% while a 10-year TIPS is yielding 0.56%, creating a breakeven rate of 1.97%.

A month ago, on Aug. 27, the 10-year Treasury yield was 2.37% versus 0.23% for a 10-year TIPS, creating a breakeven rate of 2.14%.

So inflation expectations have dropped 17 basis points in a month, and this has been during a time of rising interest rates. That’s a double whammy for investors in TIPS mutual funds, and explains the nearly 2.5% drop in a month.

For buyers of TIPS, though, prices are beginning to look a lot more attractive.

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10-year TIPS reopening auctions with a yield of 0.610%

The Treasury just posted results of today’s reopening of CUSIP 912828WU0, which went off with a yield to maturity of 0.610%, plus inflation. Just before the auction closed, Reuters’ survey of primary dealers predicted a yield of 0.577%.

Because this TIPS has a coupon rate of 0.125% based on its original July auction, buyers today are getting it at a substantial discount, about $95.72 per $100 of value. That is the adjusted price, which includes a very small amount of accrued inflation. This is the biggest discount generated by any 9- to 10-year TIPS at auction since October 2008.

10-year inflation breakeven rate. With the 10-year traditional Treasury now trading at 2.63%, this sets up an inflation-breakeven rate of 2.02% for this TIPS. If inflation averages more than 2.02% over the next 10 years, this TIPS will outperform a traditional Treasury.

When this TIPS first auctioned on July 24, it generated a yield of 0.249% and a breakeven rate of 2.26%. That’s an increase of 36 basis points in yield and a drop of 24 basis points in breakeven rate in two months. Today’s auction therefore was much more attractive for buyers, but the higher-than-expected yield also indicates lukewarm demand.

The reaction is shown well in this chart of the TIP ETF, which dropped sharply after the close of the auction at 1 p.m.:

Sept. 18Reaction to the auction

Bloomberg’s story on the auction noted “the lowest demand since the financial crisis” for inflation-protected debt.

“The likelihood of higher short-term real interest rates typically hit TIPS much faster than conventional Treasuries,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee. “If the Fed is not going to wait till it sees the whites in the eyes of inflation before it moves, there’s a far lower chance inflation gets out of control while the Fed waits for the economy to normalize.”

While a 10-year TIPS is in the mid-range for maturity, yields on 5-year TIPS have also been rising at an impressive clip. The Treasury’s Real Yields page estimates a 5-year TIPS was yielding -0.07% on Sept. 2, and now is at 0.29%, a whopping 36-basis-point increase.

TIPS of all maturities lost investors 2.7 percent in September, cutting their returns this year to 4.2 percent, according to Bank of America Merrill Lynch indexes. The securities lost investors 9.4 percent last year, according to the index.

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