TIPS remained rather unappealing the entire year, while I Bonds became a superstar investment.
By David Enna, Tipswatch.com
Here is how I can sum up this monumental year of change:
January 2021: “Inflation will never be a problem again.”
December 2021: “We are heading toward inflation Armageddon!“
In January 2021, U.S. inflation was running at an annual rate of 1.4%, continuing an 11-month string with annual inflation under 2.0%. But 11 months later, by November 2021, annual inflation had soared to 6.8%, the highest rate in 39 years. And it shows no sign of waning anytime soon. Here is the trend in annual inflation over the last year:
And yet, even with that shocking surge in inflation, U.S. interest rates continue at extremely low levels. Here are some key data points from 2021:
- The 4-week Treasury began the year yielding 0.09% and is now at 0.01%.
- The 30-year Treasury began the year at 1.66% and is now at 1.96%.
- The real yield (meaning the yield above inflation) of a 5-year Treasury Inflation-Protected Security started the year at -1.62% and is now at -1.54%.
- The real yield of a 10-year TIPS started the year at -1.08% and is now at -0.98%.
- The real yield of a 30-year TIPS started the year at -0.39% and is now at -0.38%.
- The SPY ETF (S&P 500) has had a total return of 29.4% year to date.
- VTIP, Vanguard’s short-term TIPS ETF, has had a total return of 5.25% year to date.
- SCHP, Schwab’s total TIPS fund, has had a total return of 5.48% year to date.
And finally, the 10-year inflation breakeven rate started the year at 2.01% and is now at 2.53%. In other words, investors now sense that inflation might be 52 basis points higher over the next 10 years, even though inflation has soared 540 basis points this year to a 39-year high.
Sometimes I wonder: Am I living in an alternate universe? At some point, and soon: 1) inflation will have to plummet or 2) interest rates will have to rise, dramatically. But for now, all we can do is look back on an eventful year for inflation, and an uneventful year for interest rates.
Recapping a year of TIPS auctions
CUSIP 91282CBF7, 10-year TIPS
Original auction, Jan. 21, 2021: Investors got a real yield to maturity of -0.987%, which at the time was the lowest ever for any auction of this term. The inflation breakeven rate was 2.09%, which was the highest for any auction of this term since September 2018. (Just 11 months later, that 2.09% breakeven rate looks almost nostalgic.)
Reopening auction, March 18, 2021: Investors got a much more “attractive” real yield of -0.580%, 38 basis points higher than the originating auction two months earlier. The inflation breakeven rate rose to 2.31%.
Reopening auction, May 20, 2021: The real yield came in at -0.805%, a bit higher than the record low. The inflation breakeven rate continued rising to 2.44%.
CUSIP 912810SV1, 30-year TIPS
Original auction, Feb. 18, 2021: This new 30-year TIPS auctioned with a real yield to maturity just slightly negative to inflation, at -0.04%, to fairly weak investor demand. The coupon rate of 0.125% became the record low for any 30-year TIPS auction in history. The inflation breakeven rate was 2.11%. All in all, this ended up being a fairly attractive auction, especially for TIPS traders.
Reopening auction, Aug. 19, 2021: Six months later, this TIPS reopened with a real yield to maturity of -0.292%, the lowest ever for any TIPS auction of this term. The adjusted price was a hefty $117.72 for about $104.33 of value, after accrued inflation was added in. The inflation breakeven rate was 2.17%, slightly higher than at the originating auction.
CUSIP 91282CCA7, 5-year TIPS
Original auction, April 22, 2021: The Treasury’s offering of $18 billion in a new 5-year TIPS generated a real yield to maturity of -1.631%, which at the time was the lowest real yield at auction for any TIPS in history. The inflation breakeven rate was 2.45%.
Reopening auction, June 17, 2021: This was one of the most interesting auctions of the year, and the only TIPS I actually bought in 2021. (It was a small purchase to test a new brokerage account.) This time, the real yield to maturity rose to -1.416%, boosted by the Federal Reserve’s announcement the day before that it was opening the door to tapering its aggressive bond-buying program. The real yield for this TIPS jumped by 31 basis points in a single day. The inflation breakeven rate dipped to 2.30% based on the Fed’s supposed future actions to calm inflation.
CUSIP 91282CCM1, 10-year TIPS
Original auction, July 23, 2021: There had been 110 TIPS auctions of this 9- to 10-year term since 1997 and this auction’s real yield to maturity of -1.016% set the record low yield, by a large margin. But that record wouldn’t last long. The inflation breakeven rate was 2.27%, which seems surprisingly low.
Reopening auction, Sept, 23, 2021: The real yield at this auction bounced higher, to -0.939%, again spurred by Fed statements the day before indicating actions to slow its bond-buying program. The inflation breakeven rate was 2.34%.
Reopening auction, Nov. 18, 2021: This is where things start to get weird. In November 2021, the Federal Reserve actually began tapering its bond-buying and made clear that interest-rate increases could be coming much sooner than the market expected. The market reacted with a yawn and bid the real yield to maturity of this TIPS down to -1.145%, the lowest ever for any TIPS auction of this term. The inflation breakeven rate soared to 2.74%.
91282CDC2, 5-year TIPS
Original auction, Oct. 21, 2021: Another TIPS auction, another record low yield. The Treasury’s offering of $19 billion in a new 5-year TIPS generated a real yield to maturity of -1.685%, which still stands as the lowest ever recorded for any TIPS auction of any term. The 5-year inflation breakeven rate came in at 2.89%, by far the highest rate for any 5-year TIPS auction in more than a decade. The 5-year breakeven rate was last at this level in March 2005.
Reopening auction, Dec. 22, 2021: The last TIPS auction of the year generated a real yield to maturity of -1.508% and an inflation breakeven rate of 2.73%, down from the October number.
All eyes on I Bonds
Although the fixed rate for U.S. Series I Savings Bonds stayed steady at 0.0% through 2021, the dramatic surge in U.S. inflation created intense interest in I Bonds as the inflation-adjusted variable rate jumped higher in May, and then even higher in November.
To start the year, through April 2021, I Bonds had a rather mundane six-month inflation-adjusted rate of 1.68%, but that jumped to a much more attractive 3.54% on May 1 and then to the wow-factor rate of 7.12% on November 1. The reason? U.S. inflation rose 3.56% in the six months from March to September 2021, the highest six-month increase in the 23-year history of I Bonds.
Here are the inflation numbers the Treasury uses to determine the variable rate:
Note that just two months into the next six-month rate setting period, U.S. inflation has been running at 1.33%, which would translate into an annualized six-month variable rate of 2.66%. I Bonds are likely to continue to be a very safe, very attractive investment well into 2022.
TIPS, however, remain rather unattractive, with real yields well below zero. Will 2022 bring dramatically higher real yields? I doubt those will come quickly, but once the market shifts momentum, we could see higher yields, especially for the 5-year TIPS.
At this point, I Bonds remain the most attractive inflation-protected investment in the world. As long as real yields remain depressed, your first $10,000 invested in inflation protection should be allocated to I Bonds. Then consider TIPS.
Happy New Year, everyone.
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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.
Treasury Inflation-Protected Securities 
Now that the latest (December) CPI numbers are out, are we able to update the annualized six-month variable rate of 2.66%?
My inflation report article is up now …. https://tipswatch.com/2022/01/12/u-s-inflation-surged-7-0-in-2021-the-highest-rate-in-41-years/
I don’t see a problem with buying in two parts before May 1. If you are holding for the long term, your investment results will be the same.
In thinking about the Jan vs April I Bond purchase debate, would it make any sense to buy $5k before the end of January and then wait til sometime in April to buy the second $5k tranche?
It probably doesn’t make a big difference either way, but thought I’d mention the laddering option.
You are living in an alternate universe called QE.
The FED has ignored it’s dual mandate of encouraging unemployment and controlling inflation.
Unemployment is below 5%, inflation is over 6% and the FED funds rate is zero.
The FED’s only response is to start ending QE and maybe raise rates later this year.
Unreal.
Hi – when is interested posted for I bonds? Just looked on Treasury Directs website and I didn’t see it for the new month. Say for a December 2021 purchase it should show as of 1/3/2022?
Answering my own question – directly from T Direct:
The interest is compounded semiannually. Every six months from the bond’s issue date, all interest the bond has earned in previous months is in the bond’s new principal value. Interest is earned on the new principal for the next six months. For example, in month seven, interest is earned on the original price plus six months of interest. In month 13, interest is earned on the original price plus 12 months of interest. (However, values displayed by the Savings Bond Calculator for bonds that are less than five years old do not include the latest three months of interest. These values reflect the interest penalty.) If you hold the bond for at least five years, when you cash in (redeem) the bond, you receive all the interest the bond has earned plus the amount you paid for the bond
Yes, this causes a lot of confusion, because TreasuryDirect won’t show the full interest earned until the I Bond has reached 5 years. The amounts posted will lag by three months. I Bonds actually earn interest each month you hold them an entire month, but then the interest compounds each six months.
Thank you – but still not totally following … can you given an example ??? Thank you! Filled my full allotment of I Bonds this morning. You’re website is a great resource
An example from my own account: I bought $10,000 in I Bonds in January 2021. Those earned $84 in interest the first six months (1.68% rate) and then $177 the second six months (3.54% rate). That’s a total of $261, but TreasuryDirect shows $172 interest as of January, because it eliminated the last three months of interest (half of the $177).
David, Thank you for all of the great information and happy new year. I am maxing out on IBond purchases. I know you are careful about advising but do you view VTIP and SCHD as reasonable buys at this time? I see VTIP took a big hit recently.
The hit that VTIP took on Dec. 23 was caused because it went ex-dividend on that date. On the 29th it paid out a 96 cent per share dividend, making up for the fall on the 23rd. So nothing to worry about there. I own both VTIP and SCHP in a tax-deferred account. Both have some downside risk if interest rates start rising.
Thanks. Isn’t it a given that rates will start rising?
Well, yes, but I have been saying this for half a year, and very little has happened. One good thing about VTIP, especially, is that a high rate of inflation would somewhat balance off any rise in real interest rates.
Hi –
Great website and article. Thank you for all of the information! Given how attractive i Bonds rates are right now – was thinking of using my refund to buy more bonds – as well as buying my allocation in January 2022. It looks like the IRS only allows you to buy paper i Bonds and then you have to convert these to electronic bonds?? Have you done this before??
I haven’t done the IRS refund allocation. Based on what others say, I’d advise you to file your return well before the April 15 deadline. It may take two weeks or more for the IRS to issue the paper I Bonds. That could push you after the May 1 reset, and you don’t want that. You can either keep the paper I Bonds, or deposit them at TreasuryDirect: https://www.treasurydirect.gov/indiv/research/indepth/smartexchangeinfo.htm
I did the IRS refund process last year. Filed my return at the April 15 deadline and received the paper bonds by mail in May. However, the issue date on the bonds was April 1, so they were effective prior to the May reset. (Not that great last year, where you would have preferred the May 1 interest rate, but since I’m laddering them for a long time, not that big an issue.)
In a prior article you wrote that it’s likely the new rate in May will be in a range of anywhere from 4% to 7%, but here you say that two months into the next six-month rate setting period, we are looking at an annualized six-month variable rate of 2.66% so far.
Have you tempered your expectations or just narrowed your range? Which is the more likely scenario?
No. The 2.66% number is based on actual inflation over just two months. Four months of inflation remain. If inflation averaged just 0.2% a month over those four months, the variable rate would be 4.2%.
Ah ok thanks! so the 4%-7% range is still your best guesstimate?
I’ll answer for him. It’s 2.66% with only 2 months of data added in. That’s not the expected rate if things stay the same, that’s only the gain which has already accumulated in 2 months. It will only be that low if the next 4 months have 0% inflation, which isn’t going to happen barring economic collapse. Any additional inflation in the next 4 months will only add to that total. If inflation the next 4 months matches the previous 2 and doesn’t slow down, the variable rate will be: 2.66%*3 = 7.98% annualized, higher than the current rate.
Bottom line, his 4-7% is actually a bit conservative. In my view 7% is a whole lot more likely than 4%. 5.5%-8.5% looks like a more realistic guess to me.
I have learned, though, that predicting future inflation, more than a month out, is IMPOSSIBLE. I fall into that trap every summer when I try to predict the next year’s Social Security COLA. I think you are probably right, though, that inflation will stay pretty high through March 2022, and then may begin to settle down.
Great article. Thank you. I wonder how modeling out the future 4 months of the CPI-U might look for i bonds ?? For example at this current run-rate, you are looking at 6% or higher just assuming modest positive changes from here. If you assume let’s say 0.50% m/m for the last four months which is not unreasonable you are north or 6%.
Also have you ever converted paper i bonds to electronic bonds?? I want to use my refund this year to buy even more. Thank you!!!
Peter, I converted some paper EE bonds that I’d bought for my daughter in the mid 1990’s in July this year and I’m presuming I-bonds work the same way. The process was slightly convoluted because you need to manually enter details of each and every paper bond online (all those long numbers etc.) into what is called a manifest which you then print out, attach the paper bonds in your possession to this manifest and mail to the Treasury. You can check the status online and in my case, the paper bonds were converted to electronic format and showed up in my account in approx. 3 weeks. When you log in to your TreasuryDirect account after the conversion, the paper bonds, now in electronic format show up separately titled “My Converted Bonds”. I had 7 paper bonds so inputting my details didn’t take too long & with hindsight, the process was not as cumbersome as their instructions make out to be. Hope this helps. Happy New Year!