Treasury Inflation-Protected Securities

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3% in April on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. This number, which was expected, resulted in an inflation rate of 2.0% over the last 12 months.

Holders of TIPS and I Bonds have a key interest in the non-seasonally adjusted number, which is used to set increases in the principal of TIPS and the inflation-adjusted interest rate on I Bonds. In April,  the non-seasonally adjusted CPI-U also rose 0.3%, and 2.0% over the last 12 months.

Behind the increase. The costs of fuel and energy were volatile. The price of gasoline rose 2.3% in April after falling 3.4% over the last two months. But the cost of fuel oil fell 3.0%, and electricity dropped 2.1%. Food prices rose 0.4%.

The Federal Reserve has stated repeatedly it would like to see inflation rise to 2.0% and with April’s increase this ‘headline’ number finally reached the goal. Core inflation – which strips out food and energy – rose 1.8% over the last 12 months.

You can read more about inflation in Michael Ashton’s excellent E-piphany blog, and he was on fire today:

So, with the wonderful perfection of timing that is only possible from elite policymakers, the Fed has begun to chirp about deflation fears at just exactly the time that core inflation is turning higher. Do recall that core inflation never got below 1.6% – very far from “deflation” …

This chart from the BLS shows the trend of gently increasing inflation over the last 12 months:

I have updated the Tracking Inflation and I Bonds page with the new numbers. This page tracks non-seasonally adjusted inflation.

You might not have noticed, but yields on US Treasurys touched a six-month low on Monday, meaning their value has been heading in a surprising direction: Up. (Prices on bonds rise as yields fall.) This is a surprise because just about everyone was predicting a bond rout in 2014, similar to the one we saw beginning in mid-2013. But that hasn’t happened.

Reasons? The appeal of Treasurys rises when the world faces crisis (unrest in Urkaine), the economy is slumping (GDP dropped to 0.1% in the first quarter), and riskier assets are getting stomped (the stock market has stumbled in 2014 after big gains in 2013.) Here’s an interesting chart, comparing the TIP ETF, which holds a wide range of Treasury Inflation-Protected Securities, with the Dow Jones Industrial Average, through 2014:

For TIPS holders this is all nice news – the value of your holdings has increased – but TIPS buyers are again looking forlorn, holding cash on the sidelines and waiting to invest. Prices right now do not look attractive. Here’s a recap of where we stand:

• 5-year Treasury, On Jan. 2, it was yielding 1.72%, now it is yielding 1.68%, a drop of 4 basis points.
• 5-year TIPS. On Jan. 2, it was yielding 0.01% and now is yielding -0.24%, a drop of 25 basis points.
• 5-year inflation breakeven. On Jan. 2, it was 1.71% and now is 1.92%, a rise of 21 basis points. This means a 5-year TIPS has gotten more expensive versus a traditional Treasury.

• 10-year Treasury. On Jan. 2, it was yielding 3.00% and today is yielding 2.63%, a drop of 37 basis points.
• 10-year TIPS. On Jan. 2, it was yielding 0.74% and now is yielding 0.45%, a drop of 29 basis points.
• 10-year inflation breakeven. On Jan. 2 it was 2.26% and today is 2.18%, indicating that a 10-year TIPS has gotten less expensive versus a 10-year Treasury.

• 30-year Treasury. On Jan. 2 it was yielding 3.92% and today is yielding 3.41%, a drop of 51 basis points.
• 30-year TIPS. On Jan. 2, it was yielding 1.58% and today is yielding 1.11%, a drop of 47 basis points.
• 30-year inflation breakeven. On Jan. 2 it was 2.34% and today it is 2.30%, meaning a 30-year TIPS has gotten slightly less expensive versus a 30-year Treasury.

Conclusion. The TIPS market is not leading the Treasury charge in 2014. TIPS yields have declined less than those of traditional Treasurys, except for the 5-year maturity. This means that TIPS probably aren’t more risky than traditional Treasurys, which wasn’t the case in 2013.

In a bit of a surprise, the US Treasury just announced it is dropping the I Bond fixed rate from 0.2% to 0.1% for I Bonds purchased from May 1 to Oct. 31, 2014. The fixed rate will be paired with an inflation rate of 1.84% to result in a six-month combined rate of 1.94% (annualized) for I Bonds purchased during this period.

From the announcement:

I Bond Earnings Rate of 1.94% includes a Fixed Rate of 0.10%
The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate. The 1.94% earnings rate for I bonds bought from May 2014 through October 2014 applies for the first six months after the issue date. The earnings rate combines a 0.10% fixed rate of return with the 1.84% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The CPI-U increased from 234.149 in September 2013 to 236.293 in March 2014, a six-month increase of 0.92%.

What this means. The Treasury dropped the fixed rate from 0.2% to 0.1%, disappointing buyers who were hoping the rate would continue at 0.2%. On the other hand, the inflation-rate component is getting a nice boost from 1.18% to 1.84% for the next six months.

• If you bought your 2014 allocation before May 1, you’ll get a combined rate of 1.38% for six months and then 2.04% for six months.
• If you buy anytime from May to October, you’ll get a combined rate of 1.94% for six months, and then 0.1% plus the next inflation rate, which will be set Nov. 1.

Series EE Bonds get a boost

The Treasury also announced it was bumping the base interest rate of Series EE Bonds from 0.1% to 0.5% for bonds sold from May to October 2014. Here is the announcement:

Series EE Bonds Issued May 2005 and Later
Series EE bonds issued from May 2014 through October 2014 earn today’s announced rate of 0.50%. All Series EE bonds issued since May 2005 earn a fixed rate in the first 20 years after issue.  At 20 years, the bonds will be worth at least two times their purchase price.

What it means. This does make EE Bonds slightly more attractive as a short-term investment. You can sell them after a year, with a three-month interest penalty and after five years with no penalty. But you can probably do better in a bank savings account, such as the 0.87% offered by Ally.

The real appeal of EE Bonds comes when you hold them for 20 years and get double your original investment, in effect earning 3.5%. At that point, cash them in.