When is the I Bond’s fixed rate likely to rise?

Yes, there is a slim chance we could see a higher fixed rate in 2022. But next year’s investors may still want to invest in I Bonds before May 1, to lock in the current 7.12% variable rate for six months.

By David Enna, Tipswatch.com

The Federal Reserve last month began tapering its bond buying stimulus program, and hinted that it might begin raising short-term interest rates in 2022, well ahead of the expected schedule. The reason? Dangerously high inflation continues to entangle itself into the U.S. economy.

Federal Reserve Chairman Jerome Powell made clear this week in testimony to Congress that inflation has been stronger than the Fed expected, and is running at a pace (an annual rate of 6.2%) that cannot be maintained. Among his comments:

“It’s difficult to predict the persistence and effects of supply constraints, but it now appears that factors pushing inflation upward will linger well into next year. …

“Generally the higher prices we’re seeing are related to the supply and demand’s imbalances that can be traced directly back to the pandemic and the reopening of the economy. But it’s also the case that price increases have spread much more broadly in the recent few months across the economy, and I think the risk of higher inflation has increased. …

“Inflation has run well above 2% for long enough that if you look back a few years, inflation averages 2%. … So I think the word transitory has different meanings to different people. To many, it carries a sense of short lived. We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”

Powell’s admission that our current surge in inflation won’t be short-lived is a key concession, after months of claims the inflationary surge would be “transitory.” The result of this concession should be reflected in Fed policy: 1) quantitative easing through bond buying should be scaled back quickly, and 2) short-term interest rates should begin to rise by mid-year in 2022. Both of these actions, however, could roil the stock and bond markets, as we have seen in the last week.

Eventually, both real and nominal interest rates should begin rising, ending nearly two years of absurdly low rates, at a time when inflation has surged to a 30-year high. Finally, will investors see a reasonable return on safe investments? That’s my hope.

That brings us to the question: If the Fed truly does begin changing course (despite the likely stock market turmoil that will result) when is the Treasury likely to begin lifting the fixed rate of the U.S. Series I Bond above 0.0%, where it has remained since May 2020?

The all-important fixed rate

Even though newly issued Series I Savings Bonds currently have a fixed rate of 0.0%, they remain the most attractive very safe investment in the world. Because of the I Bond’s inflation-adjusted variable rate, investors buying I Bonds in December will earn 7.12% annualized interest for six months … and at least 3.56% over the next year (probably much higher, but that’s the worse-case scenario). Compare that to the current yield of a 1-year Treasury: 0.26%.

At this point, I Bonds don’t need a higher fixed rate to be attractive. Consider this: An investor buying the $10,000 per person per year limit in December would earn $356 in interest in the first six months. That is the equivalent of more than 17 years of interest from a fixed rate of 0.2%. For this reason, it will be almost impossible to justify not buying your 2022 allocation of I Bonds before May 1, even if you think the fixed rate will tick higher on May 1. You’ll want to lock in that 7.12% for six months.

But for investors looking to hold I Bonds as a long-term investment, a higher fixed rate is always attractive. The higher, the better.

After the Federal Reserve begins pushing short-term interest rates higher (possibly in mid 2022), what are the chances we will see a higher fixed rate for the I Bond? Let’s take a look back at the Fed’s last “tightening” period, which began with hints of tapering in 2013, followed by a tapering launch in January 2014 and then finally, in December 2015, actual increases in the the Federal Funds rate.

It’s surprising to remember that the I Bond’s fixed rate rose to 0.2% in November 2013, more than two years before the Fed began raising short-term interest rates.

Based on this “past performance,” we can surmise that maybe the Federal Funds rate has little to do with real yields in general, or the I Bond’s fixed rate in particular. And that is true. Real yields (meaning yields above inflation, or currently, below inflation) are much more a factor of market sentiment. I contend that the I Bond’s fixed rate generally tracks 50 to 60 basis points below the real yield of a 10-year TIPS. At this point, a 10-year TIPS has a real yield of -1.08%, meaning the I Bond currently has a yield advantage of 108 basis points. Under these circumstances, there is very little chance the Treasury would raise the I Bond’s fixed rate above 0.0%.

So, for the I Bond’s fixed rate to rise, 10-year real yields are going to have to climb dramatically higher, probably at least 125 basis points from today’s level. But, that isn’t really possible in 2022, is it? Actually, it is possible, as demonstrated dramatically in the Fed’s last tightening period beginning in 2013:

Note that the 10-year real yield rose a remarkable 181 basis points in the period from December 2012 to September 2013. even though the Federal Reserve 1) hadn’t even started tapering its bonds purchases and 2) was still more than two years away from its first increases in short-term interest rates.

This next chart compares rate trends for the I Bond’s fixed rate, the Federal Funds rate and the 10-year real yield over the last 10 years (click on the image if you want to see a larger version):

Note that in most cases through the decade, 10-year real yields rose and fell before the Fed took action to raise or cut short-term interest rates, and the I Bond’s fixed rate rose and fell as a lagging indicator of 10-year real yields. This makes sense because the I Bond’s fixed rate is changed only twice a year: On May 1 and November 1. The Treasury makes that rate decision based on rate trends for weeks or months leading up to the reset.

When the 10-year real yield surged higher throughout 2013, the Treasury reacted with a 0.2% fixed rate in November 2013. When the 10-year real yield started slipping lower in 2016, the Treasury returned the I Bond’s fixed rate to 0.0% through November 2017. After the 10-year real yield surged to a multi-year high in late 2018, I Bonds got a fixed rate of 0.5% for a year.

A higher fixed rate is possible in 2022

To be clear, the Treasury has no announced formula for setting the I Bond’s fixed rate, and everything you just read is informed speculation. The Treasury sometimes does weird things.

To get to a higher fixed rate, it’s going to take a mighty surge in real yields, but the example of 2013 shows that this kind of surge is possible when the Fed takes away the easy money punch bowl. The difference this time, however, is that the Fed has stated clearly that it will begin scaling back its bond buying, and real yields have barely budged. The 10-year real yield — now at -1.08% — remains close to its 2021 low of -1.19%, set on Aug. 30.

My guess is that the I Bond’s fixed rate will remain in a range of 0.0% to 0.2% through 2022. Will the fixed rate rise on May 1? I’d put the odds at about 15%, and that would take a giant move higher in real yields. But hey, I could be wrong.

Final thought: Can you really pass up 7.12% for six months?

Timing your I Bond investments in 2022 will take some serious thought. Will you wait it out for the chance of a higher fixed rate? I think a lot of I Bond investors will be tempted to do that. Or will you simply take the bird in the hand — a 7.12% return for six months? It will be there for the taking in January, when a new $10,000 per person purchase cap sets in.

My opinion: Waiting until mid April 2022 to make an I Bond purchase will make sense, because by then you will know the I Bond’s next variable rate, and there’s always the slim possibility that real yields will rise by 100+ basis points. But realistically, waiting until May and beyond probably won’t make sense, because as I noted earlier, the six-month return on 7.12% will be equal to more than 17 years of a 0.2% fixed rate.

Of course, the variable rate reset on May 1 could be near 7.12% or even surpass it. But remember, when you invest in an I Bond, you get the current variable rate for a full six months, and then all future variable rates will follow for six months each. Buying before May 1 looks like the logical choice.

I’ll be writing more on this topic early next year.

More on I Bonds:

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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in I Bond, Inflation, Savings Bond | 13 Comments

10-year TIPS reopening auction gets a record-low real yield of -1.145%

By David Enna, Tipswatch.com

The Treasury’s offering of $14 billion in a 10-year TIPS reopening auction Thursday generated a real yield to maturity of -1.145%, the lowest ever for any TIPS auction of this term.

This is CUSIP 91282CCM1, and the auction created at 9-year, 8-month Treasury Inflation-Protected Security with a coupon rate of 0.125%.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or in this case, below) inflation.

So the real yield to maturity of -1.145% means investors are willing to under-perform official U.S. inflation by that amount for nearly 10 years. And they had to pay a lofty premium price to collect the coupon rate of 0.125% plus a return matching inflation. The adjusted price at this auction was about $115.60 for about $102.38 of principal, after accrued inflation is added in. This TIPS will have an inflation index of 1.02337 on the settlement date of Nov. 30.

But in a world of near-zero returns for all safe investments, this TIPS does offer the security of insurance against surprisingly high inflation over the next 10 years. Inflation fears are rising, and TIPS offer some security against those fears.

Real yields for 10-year TIPS have fallen sharply over the last 20 months, in the wake of a massive bond-buying program by the Federal Reserve combined with renewed demand for inflation protection. Here is the trend for 10-year real yields over the last 5 years, showing the plummet that resulted after the market panic in March 2020:

The Federal Reserve has officially (and gradually) begun to taper its Treasury purchases, but so far, this change has had little effect on real yields, which continue at all-time low levels. It’s a depressing time for investors interested in safety.

Inflation breakeven rate

With a 10-year nominal Treasury trading at 1.58% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.73%, at the very top of the Treasury’s history of the 10-year breakeven rate, which dates back to 2009. Normally, I’d be saying alarm bells should be ringing (avoid TIPS!) but that’s a hard call when official U.S. inflation is running at 6.2%. If inflation continues at a rate of 4% to 5% or higher over the next 10 years, this TIPS will end up being a stellar investment.

Then again, no 10-year inflation period (ending in December) has run higher than 3.9%, dating back 30 years. Have we entered a new era for inflation?

Here is the trend in the 10-year inflation breakeven rate over the last 5 years, showing the surge of inflation fears rising out of the aggressive economic stimulus of the last 20 months:

Reaction to the auction

This TIPS trades on the secondary market; it was trading with a real yield to maturity of -1.14% around 8 a.m. ET. Just before the auction closed at 1 p.m., it had a real yield of -1.16%. So the auction result of -1.145% looks like demand was mildly lukewarm, but more or less as expected. Investors were not beating down the doors for this reopening. The bid-to-cover rate was 2.43, the lowest in the last four auctions of this term.

Here is the one-day trading chart for the TIP ETF, which holds the full range of maturities. It had been trading slightly higher all morning, indicating slightly lower yields. Not much happened after the auction’s close. It looks like this auction went off as expected.

This auction closes the books on CUSIP 91282CCM1, which also set an earlier record-low for this term in its originating auction on July 22. The Treasury will offer a new 10-year TIPS on Jan. 20, 2022.

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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Investing in TIPS | 5 Comments

10-year TIPS reopens Thursday: How low can it go?

By David Enna, Tipswatch.com

The U.S. Treasury will offer $14 billion in a 10-year TIPS reopening auction on Thursday. The real yield is likely to crash through the record low for any TIPS auction of this term. And the weird thing is: Demand could be pretty high for this offering.

This is CUSIP 91282CCM1, and the auction will create a 9-year, 8-month TIPS. Here is its history:

  • CUSIP 91282CCM1 was created at an originating auction on July 22, 2021, generating a real yield to maturity of -1.016%, currently the record low for any 9- to 10-year TIPS auction. It was assigned a coupon rate of 0.125%, the lowest the Treasury will go for any TIPS.
  • Its first reopening auction was Sept. 23, 2021, where it got a real yield to maturity of -0.939%.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or in this case, below) inflation.

When you see a negative real yield to maturity, it doesn’t mean an investor is accepting a negative nominal return. But it does mean the investment will underperform official U.S. inflation.

CUSIP 91282CCM1 trades on the secondary market, so you can track its real yield and cost in real time on Bloomberg’s Current Yields page. As of Friday’s market close, it was trading with a real yield to maturity of -1.18% and a price of $113.38 for $100 of par value.

In other words, to collect that 0.125% coupon rate plus official U.S. inflation for 9 years, 8 months, investors are willing to pay a 13%+ premium to par for this TIPS. Why? Because inflationary fears are surging. A TIPS offers protection against inflation surprises, and investors are worried about where future inflation is heading.

Here’s a simple chart that shows a key yield trend in 2021:

Since the beginning of 2021, 10-year nominal Treasury yields have increased 65 basis points, while 10-year real yields have fallen 7 basis points. That’s a swing of 71 basis points. The yield spread on that chart is equivalent to the 10-year inflation breakeven rate, and with U.S. inflation currently running at an annual rate of 6.2%, it’s conceivable the spread could continue expanding.

Here is a chart comparing the nominal yield of a 10-year Treasury note against the real yield of a 10-year TIPS, over the last two years. During the depths of market panic in March 2020, the yield spread shrank to as low at 0.50%, but has been expanding ever since.

Inflation breakeven rate

With a 10-year nominal Treasury yielding 1.56% on the secondary market, CUSIP 91282CCM1 currently has an inflation breakeven rate of 2.74%, at the very top of the Treasury’s history of the 10-year breakeven rate, which dates back to 2009. This means that a 10-year TIPS is “all-time expensive” versus a nominal Treasury. Here is the history of the breakeven rate over the last two years, showing the steady surge higher, triggered by massive economic stimulus programs launched in March 2020:

If you invest in TIPS mutual funds, you probably have noticed they have done very well in 2021; much better than the overall bond market. Schwab’s U.S. TIPS ETF (SCHP) has had a total return of 6.11% year to date, after a return of 10.86% in 2020. Compare that to Vanguard’s Total Bond ETF (BND), with a total return of -1.83% year to date, following 7.71% in 2020.

TIPS are in a Goldilocks scenario right now, benefiting from a combination of lower real yields (causing net asset values to increase) and surging inflation (adding to principal balances of all TIPS). It can’t last forever, though. In fact, the turn-around can be fast, and severe, as I noted in this article: 2013: A year of surging real and nominal yields. Here is a chart from that article, showing how the overall TIPS market under-performed as the Fed prepared to scale back its bond-buying stimulus:

Thoughts on the auction

Investors in Thursday’s auction should be aware that this TIPS will carry a very high inflation index of 1.02337, meaning that the adjusted price will be boosted by about 2.3%, but investors will receive a matching amount of additional principal. If the real yield to maturity comes in at around -1.18%, the adjusted price should be about $113.70 for about $102.34 of principal, after accrued inflation is added in. But a lot can change by Thursday.

Although I won’t be a buyer, I’m expecting reasonably strong demand for this issue. Keep in mind that the December inflation accrual will be 0.83%, based on non-seasonally adjusted inflation in October. Investors know that, and the current yield probably reflects it. But investors will recoup 0.83% of the premium price in a single month.

If you are investing, you should keep an eye on Bloomberg’s Current Yields page, which shows its real yield and price in real time. The last auction of this term, in September, got a bit of surprise boost in yield. It followed by a day a Federal Reserve announcement detailing plans for future tapering of its bond-buying program. Since then, the tapering has begun, with almost no effect on the TIPS market.

I’ll report the auction results soon after the close at 1 p.m. Thursday. Here’s a history of recent TIPS auctions of this term, showing the decline into deeply negative real yields triggered by Federal Reserve actions in March 2020:

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Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Investing in TIPS | 5 Comments

Medicare Part B’s monthly premium, deductible costs will surge 14.6% for 2022

The typical person on Medicare will pay at least $289 more in 2022, just for Part B coverage, and double that to $578 for a couple. IRMAA surcharges are also increasing 14.5%.

By David Enna, Tipswatch.com

Just a month after learning their Social Security payments will increase 5.9% in 2022, retirees got some harsh news Friday: Medicare Part B premiums will increase 14.5% next year, to $170.10 a month. Also, the annual deductible for all Medicare Part B participants will increase to $233, up 14.8% from this year’s level.

The Centers for Medicare and Medicaid Services announced the new rates Friday afternoon. CMS also announced new income tiers and costs for Income-Related Monthly Adjustment Amounts, IRMAA for short, that add Part B and Part D surcharges for higher-income participants.

Any day now, if you are on Medicare, you will get a letter from CMS informing you of these new premium and deductible costs for 2022. If you planned poorly, you may be meeting up with IRMAA, and you really don’t want to meet IRMAA. These surcharges can be lofty, so it’s smart to plan ahead to limit these costs.

Let’s dive into the key Medicare changes for 2022.

Part A: Hospital insurance

Most people who reach age 65 go on Medicare Part A, even if they are still working. Medicare Part A covers inpatient hospital, skilled nursing facility and some home health care services. About 99% of Medicare beneficiaries do not have a Part A premium since they have at least 40 quarters of Medicare-covered employment.

Although coverage is generally free, Part A has some sizable deductibles and coinsurance costs, and those will be rising in 2022:

Keep in mind that most people on Medicare have a Medigap or Medicare Advantage plan that will cover all or most of the Part A deductible and coinsurance amounts. For example, all standardized Medicare Supplement (Medigap) plans, A through N, provide coverage for Part A coinsurance, and most also cover all or most of the Part A deductible costs.

Part B: Medical insurance

Medicare Part B can be described as covering “outpatient services,” things like doctor visits, some lab tests, an annual wellness exam, flu shots, diabetes screenings, etc. Medicare Part B generally pays 80% of approved costs of covered services, and you pay the other 20%. Some services, like flu shots and a wellness visit, may cost you nothing.

Part B deductible. Before Medicare pays anything, you have to meet your Part B deductible each year. For 2022, that deductible is increasing to $233, up from $203 in 2021, an increase of 14.8%. Most Medigap plans do not cover this deductible and as of Jan. 1, 2020, Medigap plans sold to new people were not allowed to cover the Part B deductible. But once the deductible is met, Medicare and Medigap plans will cover some or all of your Part B costs.

Part B premium. The Part B monthly premium, paid by all people on Medicare, is rising to $170.10 in 2022, up from $148.50 in 2021, an increase of 14.5%. CMS noted this increase is unusually high, caused by several factors:

  • For 2021, Congress put a cap on the Part B premium increase in one of its COVID-19 spending bills, holding the cost increase to just $3 a month. The 2022 increase will recoup some of that lost revenue.
  • CMS noted “rising prices and utilization across the health care system.”
  • CMS said is building “contingency reserves” due to the uncertainty regarding the potential use of the Alzheimer’s drug, Aduhelm, by people on Medicare. CMS is currently analyzing use of this drug, “which could, if covered, result in significantly higher expenditures for the Medicare program.”

So, for most people in 2022, Medicare Part B is going to cost $170.10 a month for the premium, plus the cost of the $233 deductible. That’s a total cost of $2,274 a year, up from $1,985 for 2021, an increase of 14.6%.

Beware: IRMAA is lurking

Since 2007, a beneficiary’s Part B monthly premium is based on reported income, known as MAGI, or modified adjusted gross income. According to the Social Security Administration handbook, for Medicare’s purposes MAGI is adjusted gross income (line 11 of the 2020 federal income tax form) plus tax-exempt interest.

Here are the 2022 Part B total premiums for high-income beneficiaries, which apply to income reported on your 2020 tax return:

These income-related monthly adjustment amounts affect about 7% of people with Medicare Part B. And it’s important to note that people on Medicare Advantage plans continue to pay the Part B premium, and are also subject to the IRMAA surcharges.

CMS just announced these 2022 IRMAA levels, but they are triggered by income you reported on your 2020 federal tax return. These charges are universally misunderstood. They are called 2022 IRMAA levels, but apply to the 2020 tax return. In other words, when you filed your 2020 return earlier this year, you could not know the income levels that would trigger the surcharges. And a tiny mistake can be very expensive.

When you file your 2021 return next year, realize that you won’t know the relevant IRMAA levels until November 2022, many months after you have filed. It’s a crazy system.

Part D: Drug coverage

IRMAA surcharges also apply to Medicare’s Part D premiums for drug coverage. There is no “standard” Part D premium — the cost you pay depends on the Part D insurer and plan you choose. The IRMAA cost, if any, is added on top of your base premium. People in Medicare Advantage plans don’t pay a separate Part D premium, since those plans include Medicare Advantage Prescription Drug (MAPD) coverage. But Part D is built into Medicare Advantage, and the IRMAA surcharge still applies.

Here are the Part D IRMAA levels for 2022, based on reported income for 2020:

IRMAA can pack a wallop

The IRMAA penalty isn’t a “progressive tax” that ramps up as you go over an income level. Instead, going $1 over the limit is the same as going thousands of dollars over the limit, and incurs the same surcharge. And while the IRMAA surcharges are increasing 14.5% across the board, the IRMAA income tiers only increased around 3%, less than the rate of inflation.

Here is a look at the annual costs of Parts B and D, plus IRMAA, for 2022, based on income reported for 2020:

My advice: Recognize IRMAA and plan for it

It’s worth noting that the first IRMAA tier for both singles and couples is not too daunting. It adds just $965 to the annual costs for a single filer, and $1,930 to the annual costs for a couple. But the next tier up starts to get pricey, increasing annual costs by $2,426 for a single filer and $4,853 for joint filers.

So I think people looking to take capital gains, buy a boat, make Roth conversions, etc., could feel comfortable in hitting that first IRMAA tier. In fact, anyone planning on doing major Roth conversions over a period of time should probably shoot for that level, but not higher, if possible.

Anyone reaching age 63 this year, and everyone already on Medicare, should be paying careful attention to income levels each year. That means tracking capital gains distributions, dividends, pension payments, annuity income, Roth conversions, IRA withdrawals, Social Security income, etc. It’s a lot of work, but can avoid financial pain.

Another key consideration is that Required Minimum Distributions are required from traditional tax-deferred accounts beginning at age 72. If you have sizable holdings in these accounts, you could be facing years of higher Medicare premiums triggered by RMDs. And if one spouse dies, and the surviving spouse inherits tax-deferred holdings, the problem magnifies. The surviving spouse now will file a single tax return, pushing IRMAA costs much higher.

So making some Roth conversions, within reason, before reaching age 72 makes good financial sense. Plus, it’s wise to use tax-deferred accounts for charitable giving, beginning at age 70, when qualified charitable distributions are allowed.

You can appeal an IRMAA ruling

The Social Security Administration has very specific rules that will allow you to get a waiver of the IRMAA surcharge, if you meet certain criteria for a “life-changing event” in 2020, which include:

  • Work stoppage
  • Work reduction
  • Employer settlement payment
  • Death of spouse
  • Divorce
  • Loss of pension income

You’ll need to fill out IRS Form SSA-44 to request the waiver.

Closing thoughts

The surge in Part B costs was anticipated because of last year’s congressionally-mandated limit, but an increase of 14.5% surprised me. As recently as August, Medicare trustees had projected a smaller increase of $10 from the current $148.50.

The result: A typical person on Medicare will be paying at least $289 a year more, just for Part B coverage. That’s $24 a month, and $48 a month for a couple. In addition, they most likely they will also face higher costs for Part D and Medigap coverage.

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Feel free to post comments or questions below. Comments must be civil and on-topic. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Medicare, Retirement, Social Security | 18 Comments

U.S. inflation surged 0.9% in October, well above expectations

When inflation rises to the highest level in 31 years, that is significant.

By David Enna, Tipswatch.com

Attention, Federal Reserve: This 2021 surge in U.S. inflation is no longer looking “transitory.” It’s looking dangerous.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.9% in October on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 6.2%, a three-decade high. Those results were well above economist expectations for an increase of 0.5% for the month and 5.8% year-over-year.

The annual increase of 6.2% was the largest, the BLS said, since the period ending November 1990, nearly 31 years ago. It noted that the surge in prices was “broad based,” hitting diverse areas like food, medical care, new and used cars, household furnishings and shelter.

Core inflation, which removes food and energy, rose 0.6% in October and 4.6% year of year. Those results also greatly exceeded consensus estimates of 0.4% for the month and 4.3% for the year.

As is usually the case when inflation surges, gasoline prices were a key cause. Gas prices were up 6.1% in October and are now up 49.6% in the last year. Even more troubling is the cost of food: The index for “food at home” increased 1.0% in October, and is now up 5.4% over the last year. The index for meats, poultry, fish, and eggs continued to rise sharply, increasing 1.7% following a 2.2% increase in September. The index for beef rose 3.1% over the month. Over the last decade, increases in food prices have remained relatively moderate. That is no longer the case.

The surge in prices was widespread across the economy:

  • Natural gas prices increased 6.6% for the month, the largest monthly increase since March 2014.
  • The index for new vehicles rose 1.4% in October and 9.8% year over year.
  • Costs for used cars and trucks rose 2.5% in the month, restarting an upward trend after two months of declines.
  • Shelter costs rose 0.5% for the month are are now up 3.5% year over year.
  • The medical care index rose 0.5% for the month, the largest monthly increase since May 2020.
  • One positive note: The index for alcoholic beverages decreased 0.2% for the month.

Here is the trend over the last year for both all-items and core inflation, showing a new surge higher in October after a few months of stability at an already high rate of inflation. The chart demonstrates that monthly inflation numbers are likely to continue very high through March 2022 because of low baseline numbers from early in 2021.

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates on I Bonds. For October, the BLS set the inflation index at 276.589, an increase of 0.83% over the September number.

For TIPS. The October inflation report means that principal balances for all TIPS will rise 0.83% in December, following increases of 0.21% in October and 0.27% in November. For the year ending in December, TIPS balances will have increased 6.2% to match inflation. Here are the December inflation indexes for all TIPS.

For I Bonds. The October report is the first in a six-month period (October to March) that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset May 1, 2022. After just a month, inflation has increased 0.83%, which translates to a variable rate of 1.66%. The current variable rate is 7.12%, based on inflation from April to September 2021.

Here are the relevant numbers:

What this means for future interest rates

In the very short term, I don’t expect the Federal Reserve to take any step to increase its federal funds rate. That is still probably 12 to 18 months away. But in the face of this current inflationary surge, the Fed needs to keep tapping the brakes on its bond-buying quantitative easing. So far this morning, stock market futures are mildly lower, indicating that this inflationary news isn’t scaring off investors.

The Fed says it has the “tools” to calm runaway inflation, but does it have the courage and political will to use those tools, which would involve sending short-term interest rates much higher? This action would also greatly increase the U.S. government’s borrowing costs at a time of massive deficits.

From this morning’s Wall Street Journal report:

“Federal Reserve officials are closely watching inflation measures to gauge whether the recent jump in prices will be temporary or lasting. One such factor is consumer expectations of future inflation, which can prove self-fulfilling as households are more likely to demand higher wages and accept higher prices in anticipation of higher future price growth. … Consumers’ median inflation expectation for three years from now stayed at 4.2% in October, the same as in September, according to a survey by the New York Fed. That level is the highest since the survey began in 2013.”

I do think that people shopping for groceries and seeing prices rising more than 5% over the last year are well aware of this inflationary threat. At least for now, inflation is becoming part of the U.S. economic equation. The Fed knows this.

I’ll end with this commentary from inflation guru Michael Ashton, author of the E-piphany blog:

“Seriously, this month’s report – while expected, at some level – turns my stomach. We have learned these lessons, painfully, long ago: you can’t spend in an out-of-control fashion and you can’t print the money that you’re spending. That’s fiscal policy 101 and monetary policy 101. Flunk them all, I say. … “

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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he discusses can purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in I Bond, Inflation, Investing in TIPS | 15 Comments