I was out of town last week and didn’t get a chance to write about the U.S. inflation rate in July, which was unchanged from June, in other words … zero inflation in July.
This is the ‘headline’ inflation rate – the Consumer Price Index for All Urban Consumers (CPI-U) – which is the rate that determines principal adjustments for holders of TIPS and will help to determine the next 6-month adjustment in the inflation-adjusted interest rate for I Bonds.
The core CPI – which excludes volatile food and energy prices – rose by only 0.1 percent in July. The core rate is the one the Fed watches closely, but doesn’t directly affect interest rates for TIPS and I Bonds.
Over the last 12 months, headline inflation has increased a meager 1.4 percent, and core inflation was up 2.1 percent. The trend since spring has been remarkable:
It’s great that inflation is muted, but for holders of TIPS and TIPS mutual funds this is a four-month double whammy. Many people buying TIPS in the last year have accepted yields to maturity that are negative to inflation. Since April, they have also seen their principal balance decline by 0.3%. Ouch.
I Bond holders also might be affected come November, when the new six-month interest rate will be unveiled. The I Bond inflation component is based on the difference between the March and September levels of the CPI-U. In March, inflation was 0.3%, so for now, I Bond holders are looking at a zero interest rate for six months (November 2012 to April 2013), but we’ll have to wait for the August and September inflation numbers to know for sure.
Even at zero interest, though, I Bonds might be preferable to TIPS paying a negative real yield at a time of zero inflation. Negative plus zero = negative.
Prediction. We can expect the buying appetite for I Bonds to dry up completely if they pay a zero base rate and a zero inflation adjustment beginning in November.