By David Enna, Tipswatch.com

The Consumer Price Index for All Urban Consumers increased 0.4% in December on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 1.4%. Core inflation, which strips out food and energy, rose 0.1% in December and 1.6% for the year.

All of these number were close to the consensus predictions, with the year-over-year number missing on the high side for all-items inflation and on the low side for core inflation. In other words, no real surprises.

This report closes out the year of 2020, which ended up with annual inflation of 1.4%, the lowest rate since 0.7% in 2015.

Overall U.S. inflation surged in December primarily because of a whopping 8.4% increase in the gasoline index, which the BLS said accounted for more than half the overall inflation increase. However, gas prices were still down 15.2% for the year, indicating they have room to rise higher. Other key trends:

• Food prices were up 0.4% for the month and up 3.9% for the year.
• Shelter prices rose 0.1% and were up 1.6% for the year.
• Apparel prices rose a sharp 1.4%, but were down 3.9% for the year.
• The cost of medical care services dropped 0.1%, but was up 2.8% for the year.
• The cost of used cars and trucks fell 1.2% for the month, but were 10% higher for the year.

Here is the 12-month trend for both all-items and core inflation in 2020, showing the sharp decline during the pandemic’s first surge in March, and then the gradual rise higher and stabilization in the second half of the year.:

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. 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 for I Bonds. For December, the BLS set the inflation index at 260.474, 0.09% higher than the index for November.

For TIPS. The December inflation report means that principal balances for all TIPS will rise 0.09% in February, after falling 0.06% in January. That’s only a net increase of 0.03% over two months. Keep in mind, however, that non-seasonally adjusted inflation has been running lower than seasonally adjusted. This trend will reverse in future months because both versions balance out over 12 months.

Here are the new February Inflation Indexes for all TIPS.

For I Bonds. The December report is the third in a six-month series that will determine the I Bond’s new inflation-adjusted variable rate, which will be reset on May 1. So far, halfway through the rate-setting period, inflation is 0.07% higher, which would result in a woefully small variable rate of 0.14% for I Bonds, versus the current 1.68%. But … three months remain, and a lot can happen in three months.

Here is the trend so far for the current period, along with data for recent rate resets:

Where are we heading?

Inflation was “lower than expected” in 2020, running at just 1.4%. While that is welcome news, investors in TIPS and I Bonds don’t do well when inflation runs lower than expected. But … inflation expectations are rising, with the 10-year inflation breakeven rate currently running at 2.08%, higher than recent trends.

One important factor in rising inflation — definitely reflected in rising gasoline prices — is the decline in the value of the U.S. dollar, down about 10% against international currencies since mid-2020:

Inflation fears are also rising because of recent political events, with the Democratic Party taking control of the White House and both houses of Congress. The theory is that this will increase future stimulus spending and federal deficits, spurring inflation in the U.S. economy.

Will inflation surge in the future? I don’t know. TIPS and I Bonds, however, provide protection against unexpectedly high future inflation. They continue to make sense as a allocation in your overall financial plan.

The Treasury will offer a new 10-year TIPS at auction on Jan. 21, and I will be previewing that auction over the weekend.