US inflation fell into deflation in December, down 0.1%; what does this mean for I Bonds and TIPS?

The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.1% in December on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months – the year 2015 – the all items index increased 0.7%.

Inflation over the last six months, ending in December, was 0.0%. The primary cause: Falling gasoline prices, which were down 4.0% in December and a whopping 19.7% for the year. Fuel oil costs were down an even stronger 7.8% in December and 31.4% for the year.

Those are amazing numbers, but it doesn’t stop there. In December food prices fell 0.1%, and are up just 0.8% for the year. New vehicle prices also fell 0.1% in December, along with apparel prices, down 0.2%. On the up side were shelter costs, up 0.2%, and medical care services, up 0.1%.

So even when you strip out food and energy and look at ‘core inflation,’ inflation rose only 0.1% in December. However, for the year 2015 it rose 2.1%, its highest 12-month change since the period ending July 2012.

Holders of TIPS and I Bonds are also interested in non-seasonally adjusted inflation, which is used to determine principal adjustments on TIPS and set future interest rates for I Bonds. In December, the inflation index was set at 236.525, down 0.34% from November.

What this means for TIPS. This was the inflation index’s fifth consecutive deflationary month, and will mean that principal balances on TIPS will fall another 0.34% through February. In July 2015, the inflation index stood at 238.654. In December, it was 236.525, down 0.89% for those five months.

There’s a TIPS auction on Thursday, and today’s inflation number does mean that the new issue will see falling principal through February. But that fact should be reflected in the auction price.

What this means for I Bonds. The next reset of the I Bond’s inflation-adjusted interest rate is coming May 1, based on inflation from September 2015 to March 2016. In the first three months of that period, inflation has declined 0.59%. If that trend continues, I Bonds will end up with a negative inflation-adjusted rate, which will will wipe out any smaller fixed rate and mean I Bonds will pay 0.0% for six months. This happened in 2015 and could happen again in 2016. But we have three months to go. I have updated my ‘Tracking Inflation and I Bonds‘ page with these new numbers.

decAdvice: Hold off on buying your allocation of I Bonds in 2016 until you see if I Bonds will be paying 0.0% for six months. If that is true, wait until the Nov. 1 reset.

More advice: Don’t let these numbers scare you into selling older I Bonds with fixed rates of 0.7% or higher. Those I Bonds – issued before May 1, 2009 – are a valuable asset. You should hold them to maturity or until you absolutely need the cash. If you decide to sell I Bonds, choose newer issues with fixed rates of 0.0%.

Here is the non-seasonally adjusted inflation trend for the year of 2015:

2015-inflation

 

 

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2 Responses to US inflation fell into deflation in December, down 0.1%; what does this mean for I Bonds and TIPS?

  1. Jimbo says:

    Looking at your chart, the non-seasonally adjusted inflation rate was a whopping 0.10% during 2015. Reflecting this, TIPS values were basically flat. Savings accounts beat the CPI-U (mine are at 1%). Any CD beat the CPI-U (mine probably average 2%). In comparison, the DOW was down 0.75% and housing prices in my neighborhood went up around 10% (bubble part deux).

    Looking forward in 2016, the deflationary trend continues making TIPS losers to even cash stuffed under a mattress. With the stock markets down 10% in 20 days, it remains to be seen if the Fed will raise rates further this year. Jim Cramer was crying a river about the Fed’s “restrictive” monetary policies on Mad Money today.

    With a bunch of CD’s maturing this year and TIPS yields still pathetic, it looks like I’ll just continue to ladder CD’s over the next few years. Sure there’s a lot of interest rate risk involved in that. However, at this point in the game I’ll be happy to just marginally beat the CPI-U. If inflation remains tame for the next five years, getting over 2% might even do the trick.

    Iran hasn’t even started selling oil on the international market again and today oil fell to it’s lowest level since September of 2003. It was less than $28 a barrel! Heck, yields on nominal 10 year Treasuries fell below 2% today (the 30 year is at 2.7%). That makes any CD with a term of five years or less and an interest rate over 2.0% look pretty good in comparison.

    When the Fed raised rates in December, I started having second thoughts about continuing to ladder CD’s as far out as 5 years. With the world economy in turmoil (again), I’m not so sure that the Fed will be able to raise rates as much as they had signalled. Once again, the year starts off on an interesting note. Once again, I’m waiting for TIPS yields and principle balances to rise, not fall.

  2. Silver_Stacker says:

    Would the Feds really want to see another 6 month period of no one buying I Bonds because of 0%?

    Any chance you feel that they’d keep it artificially high just to keep cash flowing in?

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