Savings Bond holders: Your I Bond interest rate could drop to 0.0% on May 1

Posted on February 27, 2014 by Tipswatch

I Bonds

We are supposed to be in a year of rising interest rates, but so far that hasn’t been true. And holders of I Savings Bonds could be in for a bit of of a ‘shock’ on May 1, when the inflation-adjusted interest rate is re-set for all I Bonds.

With two months left to go, inflation data are pointing to a negative number for the inflation-adjusted interest rate on I Bonds. That could change once the February and March data are in, of course, but right right now we are looking at a -0.1% inflation-adjusted rate.

I Bonds pay a combination of two interest rates:

  • The fixed rate, currently 0.2% for as long as you hold the bond, up to 30 years – will never change. So if you bought an I Bond in 2013 with a zero fixed rate, it will continue to have a zero fixed rate. Purchases through April 30, 2014, will have a fixed rate of 0.20%. I Bonds I bought back in 2000 still carry a fixed rate of 3.4% and will continue to do so through 2030.
  • The inflation-adjusted rate changes each six months to reflect the running rate of inflation. That rate is currently set at 1.18% annualized. It will adjust again on May 1, 2014, for all I Bonds, no matter when they were purchased.

To understand how that inflation-adjusted rate is set, take a look at the last adjustment, on Nov. 1. To set the rate for November through April, the Treasury looks at the CPI-U inflation index from the end of March to the end of September. Here is the formula:

End of September 234.149 / End of March 232.773 = 1.0059, or .59%, the current six-month rate, which translates into an annual rate of 1.18%.

The Treasury uses the non-seasonally adjusted CPI-U, and that has been trending negative since the end of September.

End of Month Inflation index Monthly non- adjusted inflation
Sept. 2013 234.149 0.12%
Oct. 2013 233.546 -0.26%
Nov. 2013 233.069 -0.20%
Dec. 2013 233.049 -0.01%
Jan. 2014 233.916 0.37%
Feb. 2014 ?? ??
Mar. 2014 ?? ??

If the Treasury were setting the I Bond inflation-adjusted rate today, it would use this formula:

End of January 233.916 / End of September 234.149  = .999, or -0.1%.

Will the rate end up negative after the full six months? I would guess not, since higher heating fuel costs are likely to give February and March numbers a little boost. That is what happened in January with the .37% non-seasonally adjusted rate of inflation.

What happens if the rate goes negative?

An I Bond can never pay less than 0.0% interest and the accrued principal balance will never go down. (This is an advantage I Bonds have over TIPS in deflationary times. The principal balance of a TIPS does go down, but never below the original purchase.)

If the I Bond inflation-adjustment is set below zero, it is subtracted from the base fixed rate to determine the net interest of those six months. That number cannot go below zero.

For an I Bond purchased in 2014 and paying a base rate of 0.2%, an inflation-adjusted rate of -0.1% would result in a combined rate of 0.1% for six months. For I Bonds with a zero base rate, the combined rate would be 0.0% for six months.

The I Bond inflation-adjusted rate has gone negative only once, from May to November 2009, when it was set at a whopping -2.78%. During those six months, unless you bought your I Bonds before October 2001, you were earning zero interest.

Check out historical I Bond fixed rates and inflation-adjusted rates.

Should you dump I Bonds paying 0.0%?

If your strategy is to buy I Bonds up to the limit each year _ $10,000 per person at Treasury Direct and up to $5,000 in paper I Bonds as a tax refund – I would definitely urge you to ride out the six months at zero interest. Because of the purchase limits, you need to hold I Bonds until you need the cash.

Other folks who stay below the purchase limit could sell their I Bonds with a zero base rate and purchase again after Nov. 1, when the inflation-adjusted rate will be re-set, probably higher. The risk is whether the Treasury will continue the 0.2% base rate, which it set in November 2013 after three years at 0.0%.

Posted in I Bond, Inflation, Investing in TIPS | 6 Comments

Recapping the week: 30-year TIPS, mild inflation

Posted on February 23, 2014 by Tipswatch

I was on vacation last week in sunny Florida and had limited Internet access. But I wasn’t totally out of touch: I had satellite radio on my cheapo Hyundai rental car, and could listen to CNBC and Bloomberg Radio. So I spent Thursday morning, driving to Sarasota, listening for the January inflation number.

In a two-hour drive, I never heard the number. What I did hear was this: “Treasurys are weakening today on the January inflation number.” That perked my interest.  There’s a TIPS auction today! What was the inflation number? Never heard. What was happening to Treasurys? That I did hear: “The 10-year Treasury yield rose from 2.75% to 2.76%.” One basis point! That is not news, and inflation had nothing to do with it.

The inflation number, by the way, was 0.1% in January for the seasonally-adjusted Consumer Price Index for All Urban Consumers (CPI-U). Over the last 12 months, inflation was up a very mild 1.6%, still well below the Federal Reserve’s target of 2.0% and ‘danger level’ of 2.5%.

Read the full inflation report.

The non-seasonally adjusted CPI-U is used to determine the inflation adjustment to principal on TIPS and the future interest rate on I Bonds. In January, the non-seasonally adjusted number was 0.4%, but for the last 12 months the number remains at 1.6%.

Inflation is continuing at a very mild level. Gasoline prices fell 1.0% in January, but fuel oil prices increased 3.7% and natural gas was up 3.6%, the result of a wicked winter on the East coast.

Core inflation, which strips out food and energy, increased the same 0.1% in January and 1.6% for the last 12 months.

30-year TIPS auction

Of course, CNBC didn’t report on the TIPS auction. No mainstream media report on TIPS auctions, especially in the hour after the close. Thursday’s auction for a new 30-year TIPS, CUSIP 912810RF7, went off with a coupon rate of 1.375% and a yield to maturity of 1.495%. That result was slightly higher than expected; a week earlier I had noted a yield of 1.42% looked likely. But, no big surprises.

Read the TIPS auction announcement.

However, this was the highest yield for any 29- to 30-year TIPS at auction since June 2011, when a 29-year, 8-month TIPS went off at 1.744%. That was just before the beginning of a 24-month boom in Treasurys, which eventually deflated (a bit) in mid 2013.

Over the week, TIPS weakened as yields increased, but you can see from this chart that the Thursday auction, which closed at 1 p.m., was a rallying point for TIPS:

Week for TIPS

The TIP ETF is shown here in blue. It holds the full range of TIPS maturities. Over the last week, it lagged behind IEI (intermediate Treasurys) and AGG (the overall bond market). This means TIPS yields were rising faster than the overall bond market, resulting in a lower price.

When you see a chart like this, you can conclude that TIPS yields are increasing at a higher rate than the overall bond market, and that should mean a lower inflation breakeven rate. Thursday’s auction resulted in an inflation breakeven rate of 2.23%, in the ‘normal range’ but 5 basis points less than looked likely a week earlier. A lower breakeven rate means that TIPS are cheaper against a nominal 30-year Treasury.

When you are a buyer, cheaper is better.

Reaction to the auction.

The Wall Street Journal noted that demand for the 30-year TIPS was ‘tepid,’ possibly because inflation continues to be muted:

(P)aying for inflation protection is a hard sell these days. The latest CPI reported Thursday morning showed consumer prices gaining just 0.1% last month and 1.6% over the year. Core prices, which exclude volatile food and energy costs, also rose a mere 0.1%. These measures fall well short of the Federal Reserve’s 2% long-run inflation goal. …

The massive amount of bets that piled up against TIPS in 2013 actually helped the market bounce back in January. But bond traders now say that for TIPS to keep buyers around, the economy will have to start showing more substantial signs of inflation.

Posted in Investing in TIPS | 6 Comments

30-year TIPS auctions at 1.495%

Posted on February 20, 2014 by Tipswatch

I am away from a computer today, and in fact don’t have Internet access. (It’s called vacation!)

Sorry I can’t post a full analysis until Sunday. Inflation report was also mild today, more on that to come.

Posted in Investing in TIPS | Leave a comment

Next up: 30-year TIPS will auction Feb. 20, 2104

Posted on February 14, 2014 by Tipswatch

The U.S. Treasury formally announced yesterday that it will auction a new-issue 30-year Treasury Inflation-Protected Security on Feb. 20. This is CUSIP 912810RF7, and the coupon rate and yield to maturity will be determined at auction. Here’s the fact sheet.

How this shapes up. Because this is a new issue with a positive yield, the coupon rate and yield to maturity should be fairly close. If the auction were today, the coupon rate might be 1.50% and the yield to maturity around 1.42%. But a lot can happen in a week. Here are some data sources to check before the auction:

  • The Treasury’s Daily Real Yield Curve Rates, which right now are indicating a yield of 1.42%. That’s down about 16 basis point from where we opened the year.
  • Bloomberg’s Current Yields, which reflects current trading but can be a little misleading. It shows the longest-term TIPS trading at the same 1.42%.
  • The Wall Street Journal’s closing price list for TIPS, which shows that the TIPS maturing 2043 Feb 15 closed Thursday at 1.40%.

The yield trend line. The Treasury offers only three 30-year TIPS auctions a year – one new issue in February and two re-openings (June and October). In 2013, we saw just how volatile 30-year Treasurys can be. CUSIP 912810RA8 auctioned on Feb. 21, 2013, with a yield to maturity of 0.64%. It was reissued in June with a yield of 1.42% and in October at 1.33%. In just five months, this TIPS lost almost 19% of its value on the secondary market.

But the trend also indicates that 30-year TIPS yields have been fairly stable since mid-2013. Buyers at the June 2013 auction are sitting on a slight gain.

What is normal? My opinion: In ‘normal’ times a long-term TIPS should pay at least 2% above inflation. As the Federal Reserve ends its bond-buying stimulus and the economy continues to improve, we might start to see hints of ‘normal.’ To make my case, I present the history for every 29- to 30-year TIPS auction:

30-year TIPS auctionsInflation breakeven rate. The 30-year nominal Treasury is yielding 3.70% and with the 30-year TIPS yielding 1.42%, plus inflation, this sets up a breakeven rate of 2.28%. That means this TIPS will outperform a traditional Treasury if inflation averages more than 2.28% over the next 30 years. Not expensive, not cheap, as this chart shows:

30 year breakeven

Best purchased in a tax-deferred account. I have noted before that a 30-year TIPS can end up being a cash-flow drain until it matures. The reason: You have to pay taxes on the inflation-adjusted interest in the year it is earned, but you don’t see that money until maturity. This TIPS, with a coupon rate of around 1.5%, is going to be close to cash-flow neutral if inflation averages 2.5% over 30 years.

Example: Let’s say you buy $10,000 of this TIPS and the coupon rate is 1.5% and the inflation rate averages 2.5%. In the first year you will get $150 of interest and $250 in inflation-adjusted principal. That’s $400 total, and if your marginal tax rate is 38%, you would owe $152 in taxes. The TIPS paid you $150, so you are $2 cash flow negative.

My philosophy on TIPS is to buy and hold to maturity as a way to push inflation-protected money forward into retirement.  Although I have bought 30-year TIPS in the past (and still own them), they no longer are in my target range. So I’ll pass on this. (Go ahead, Treasury, tempt me with 3.5% above inflation and watch me change me mind.)

Posted in Investing in TIPS | 3 Comments

myRA accounts: Training wheels on the road to retirement?

Posted on February 13, 2014 by Tipswatch

The Treasury has unveiled details  of of the new myRA retirement savings plan announced by President Obama in his State of the Union address on Jan. 28. The accounts, which Treasury calls ‘a simple, safe and affordable way to start saving,’ won’t be available until later this year, but we can start examining the details now:

  • MyRAs will be Roth IRA accounts, initially offered through employers, and will be equivalent to savings bonds – backed by the full faith and credit of the United States.
  • Savers will be able to open an account with as a little as $25 and contribute $5 or more every payday.
  • MyRAs will be available to anyone who has an annual income of less than $129,000 a year for individuals and $191,00 a year for couples.
  • MyRAs are designed for savers who don’t have access to an employer-sponsored retirment savings plan, but the Treasury adds that people who ‘are looking to supplement a current plan’ can also participate. So that means myRAs are open to  everyone who qualifies for a Roth IRA and works at a participating employer.
  • Annual contributions will be capped at the Roth IRA limits: $5,500 per year (or $6,500 if you’re 50 or older).
  • MyRAs will earn interest at the same variable rate as the Government Securities Investment Fund in the Thrift Savings Plan for federal employees. This fund had a return of 1.89% in 2013, but that will change with market conditions.
  • Once a saver’s myRA reaches $15,000, or after 30 years, the balance will be rolled over to a private-sector retirement account. The Treasury hasn’t yet determined how this will be handled.
  • Contributions can be withdrawn tax free at anytime; earnings generally can be withdrawn tax free after age 59½.

Some thoughts. I can’t criticize any plan that will encourage people to save. The myRA proposal emphasizes safety and is built into an attractive Roth IRA package, offering tax-free money in retirement. It is simple, has zero fees and is extremely low risk, because balances can never decline. And use of payroll deductions will encourage ‘auto-saving,’ which is crucial to building wealth.

As an opening step, fine. But let’s say this is the sole retirement savings plan of a person in her mid 20s. She is investing in small amounts, earning less than 2%, and eventually building a nest egg of $15,000. Wouldn’t that person – who is young and can afford to take risk – do better by opening a Roth IRA and investing in a low-cost stock mutual fund?

This person needs to strip off the training wheels and really start saving for retirement, because $15,000 just won’t cut it. But if a myRA account gets that process rolling, and the $15,000 is smartly invested after it is rolled over, it is a good beginning.

I think the Treasury needs to set up protections for people who reach the $15,000 limit, because I fear these folks could fall prey to investment predators – bankers pushing  load-heavy mutual funds, insurance agents peddling high-cost annuities, day-trading ‘training’ schools, and on and on.

How can the Treasury move these myRA ‘graduates’ into customer-friendly investment houses like Vanguard and Fidelity? This will be a huge issue.

Posted in Investing in TIPS, Savings Bond | 21 Comments