Treasury Inflation-Protected Securities

How much are your I Bonds actually earning?

Posted on May 5, 2024 by Tipswatch

By David Enna, Tipswatch.com

Last week, the Treasury set the fixed rate for I Bonds purchased from May to October 2024 at 1.3%, which combined with a variable rate of 2.96% results in a composite rate of 4.28% for six months.

As it turns out, that 4.28% composite rate also applies to I Bonds purchased from November 2023 to April 2024, because those also had a fixed rate of 1.3%. But what about I Bonds purchased in previous years, with fixed rates as low as 0.0%?

All I Bonds — no matter when they were purchased — will have the inflation-adjusted 2.96% variable rate applied for a full six months. The starting month depends on the original month of purchase, following this chart from TreasuryDirect:

For example: If you bought I Bonds in January 2024, that investment will earn a composite rate of 5.27% for six months, and then in July will begin earning 4.28% for six months. A purchase in April 2024 will earn 5.27% for six months, and then in October begin earning 4.28% for six months.

But what about those earlier I Bonds in your inventory, with much lower (or possibly higher) fixed rates? Any I Bond with a fixed rate of 0.0% is going to earn the variable rate, with no added fixed rate. So those will transition from earning the previous variable rate of 3.94% for six months to 2.96% for six months.

In this chart, I have compiled the new composite rates (which will roll into effect based on the original month of purchase) for all I Bonds back to November 2016, and then selected I Bonds with varying fixed rates back to May 1999. The chart also shows the current value of these I Bonds, assuming the I Bonds were purchased in the first month of each time period:

Note that the May 1 value shows total interest earned, ignoring the Treasury’s three-month penalty for redemptions before five years.

Thoughts

Because of the inflation protection built into I Bonds, earning 2.96% for six months isn’t a dreadful thing. Get over it! But … at a time when 4-week Treasury bills are yielding 5.47%, that 2.96% is looking weak. You can reach a similar conclusion with other low fixed rates:

A fixed rate of 0.10% will generate a composite rate of 3.06% for six months.
0.20% = 3.16%
0.30% = 3.26%
0.40% = 3.37%
0.50% = 3.47%
0.70% = 3.67%

As I have written recently, this year I have redeemed 0.0% I Bonds to purchase the new 1.3% I Bonds, both in the traditional way in March and in gift-box swaps in April. I still have one set of 0.0% bonds remaining (from 2017) and a rather large collection of 0.1% fixed-rate I Bonds dating back to 2013.

At this point, I would not redeem any I Bond with a fixed rate of 0.2% or higher.

Also in the chart, notice the I Bonds issued from May to October 2007 with a fixed rate of 1.3%, same as today’s. Those I Bonds are very close to doubling in value in 17 years. They have generated a tax-deferred, annualized nominal return of 3.92% over a time when inflation averaged 2.4%. We can expect similar performance from these 2024 I Bonds.

My thinking: If market real yields remain high into the end of 2024, I will be looking to redeem — selectively — my remaining set of 0.0% I Bonds and some 0.1% versions to make gift-box purchases at 1.3%. I am in no rush to do this, because the 1.3% fixed rate will apply to all I Bond purchases through the end of October.

But what if real yields start declining, deeply? Then I will be definitely looking to make the swap to the 1.3% fixed rate because the November fixed-rate reset will be likely be lower than 1.3%.

At this point, there is no way to know. So just wait it out to October.

I am not a fan of stacking 10+ sets of gift-box swaps, because that will lock up the money for future distribution. One of the advantages of I Bonds is the ability to redeem after one year. But no one can redeem an I Bond that can’t be delivered because of the purchase cap.

Another option. If you are committed to redeeming low-fixed-rate I Bonds to buy the 1.3% version later this year, you could redeem now, place the proceeds in a money market account or in rolling 4-week T-bills earning 5.5% and then use that cash to buy the I Bonds in October, or possibly November.

You’d probably earn more than the 2.96% variable rate for several months. But there are two negatives to this strategy: 1) You will owe 2024 federal taxes on the interest earned, and 2) There is a slim chance that short-term yields could fall off sharply in the next few months.

Here’s a decent summary of the situation from CNBC, which includes (of course) a financial adviser telling you to sell your I Bonds:

If you need the money …

I keep stressing that the proper approach to I Bonds is to build a large reserve of inflation-protected, tax-deferred cash. At some point, you should start spending that money, either in retirement or to achieve other life goals. If you need the money, target the lower-fixed-rate I Bonds for the first redemptions.

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bonds: Here’s a simple way to track current value

• I Bond Manifesto: How this investment can work as an emergency fund

* * *

Feel free to post comments or questions below. If it is your first-ever comment, it will have to wait for moderation. After that, your comments will automatically appear.Please stay on topic and avoid political tirades.

David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.

Posted in Cash alternatives, I Bond, Inflation, Retirement, TreasuryDirect | 29 Comments

Treasury holds I Bond fixed rate at 1.3%; composite rate falls to 4.28%

Posted on April 30, 2024 by Tipswatch

EE bond’s fixed rate stays at 2.7%; doubling period holds at 20 years

By David Enna, Tipswatch.com

After signaling for a few days that it would hold off to May 1 to announce new rates for U.S. Series I Savings Bonds, the ever-unpredictable Treasury did it early anyway, and it matched my expectations.

The I Bond’s new fixed rate holds at 1.3% for purchases from May to October, and the composite rate falls from April’s 5.27% to 4.28% for new purchases.

The I Bond’s fixed rate is important for investors. It is permanent and stays with an I Bond until redemption or maturity in 30 years. This new fixed rate only applies to I Bonds purchased from May to October 2024.

The inflation-adjusted variable rate applies to all I Bonds, no matter when they were issued. It changes every six months and the starting date of the change depends on the month you bought the I Bond. This new 2.96% variable rate is based on non-seasonally adjusted inflation from October 2023 to March 2024.

The composite rate is based on a combination of the fixed and variable rates, using this formula:

The new inflation-adjusted variable rate rolls out over time, as I noted. For example, if you bought an I Bond in April 2024, it would earn 5.27% through September, and then transition to 4.28% for six months beginning in October.

Track the history of the I Bond’s variable rate on my Inflation and I Bonds page.

No surprises

I Bond watchers (like me) had been forecasting that the fixed rate would hold at 1.3%, based on a ratio of 0.65 applied to the six-month average of 5- and 10-year real yields. and then rounded to the tenth decimal point. It was reassuring to see the forecast worked, this time. This gives us a little more supporting data on how the Treasury makes this decision.

Reaction

I have been recommending making your 2024 I Bond purchase in April to lock in both the 1.3% fixed rate and 5.27% composite rate for a full six months. Now that the fixed rate held at 1.3%, that strategy looks solid. Now we can await the November 1 rate reset.

Timing your investments can be important, because I Bond purchases are limited to $10,000 per person per year unless you use your tax return to get paper I Bonds or add to your holdings through gift-box, trusts, or business-owner strategies. Whatever rate is set in November will be available for purchase in January 2025, when the purchase limit resets.

Even though T-bills have yields higher than the I Bond’s new composite rate of 4.28%, these savings bonds still make sense for investors looking to build a large cash reserve that is inflation-adjusted, tax-deferred and totally safe. Right now, it is T-bills for the short-term, I Bonds for the long-term.

EE Savings Bond

The Treasury decided to hold the fixed rate on the EE Savings Bond at 2.70%, well below the yield of comparable nominal Treasury investments. I had been predicting the rate could rise to 2.8% or 2.9%, based on the trend in yields for the 10-year Treasury note (currently yielding 4.63%).

The Treasury also held the EE bond’s doubling period at 20 years, meaning this savings bond will yield 3.53% compounded if held for 20 years. I had expected that decision, but honestly, it would be more fair to set the doubling period at 18 years, creating an effective yield of 4%.

I doubt there will be much interest in EE Savings Bonds when T-bills are earning nearly 5.5% and the 20-year Treasury bond yields 4.86%. Both of those make more investment sense. Too bad.

What’s your reaction?

Investors are sorting through a lot of issues when considering I Bonds these days. T-bills offer a better rate of short-term return, with no fear of a penalty for early redemption. Treasury Inflation-Protected Securities offer better real returns, but with more complexity and potential market fluctuations.

I suspect most I Bond investors have already purchased their allotment for 2024 and are now ready to sit back and enjoy life.

FYI, earlier today (April 30) I looked on TreasuryDirect and it “appeared” you could still set a purchase for April 30, 2024, which in theory would get the higher April composite rate. Forget it. I have already gotten feedback from a reader that a purchase entered today is getting the May rate.

The Treasury really needed to clarify its wording, which said for several days, “The current rate of 5.27 percent is available until 11:59 p.m. Eastern Time on Tuesday, April 30. The new rate becomes available at midnight.”

That was highly suspect.

Now, on the afternoon of April 30, TreasuryDirect has gone in and changed the wording on its I Bond FAQ page to this bizarre past-tense instruction:

The rate of 5.27 percent was available until 11:59 p.m. Eastern Time on Tuesday, April 30. The current rate of 4.28 percent became available at midnight.

Treasury, you screwed this one up.

Post your ideas and thoughts in the comments section below.

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bonds: Here’s a simple way to track current value

• I Bond Manifesto: How this investment can work as an emergency fund

* * *

Posted in Cash alternatives, EE Bonds, I Bond, Retirement, Savings Bond, TreasuryDirect | 56 Comments

Real yields are rising, but haven’t yet hit highs of 2023

Posted on April 28, 2024 by Tipswatch

By David Enna, Tipswatch.com

I’ve been watching with fascination as market real yields of Treasury Inflation-Protected Securities have been steadily rising in recent weeks. We can look at several apparent causes:

U.S. inflation has perked higher since the beginning of the year, with the annual rate of all-items CPI rising from 3.1% in January to 3.5% in March.
The U.S. economy is showing few signs of stalling, with the job and housing markets remaining robust. The unemployment rate stands at 3.8%, still close to a 10-year low.
The bond market’s inflation expectations have been steadily increasing, with the 10-year inflation breakeven rate rising from 2.21% on Jan. 2 to 2.42% on April 24.
The Federal Reserve has backed off dovish talk and is now preaching a “higher for longer” message for U.S. short-term interest rates.
The U.S. Treasury’s funding needs continue to rise with ever-growing federal deficits, causing longer-term yields to remain elevated.

Definition: The real yield to maturity of a TIPS is its above-inflation annual return over the life of the investment. For example, on April 18 the Treasury auctioned a new 5-year TIPS with a real yield of 2.242%, which means that TIPS will out-perform official U.S. inflation by 2.242% over the 5-year term.

Here is the trend in 5-, 10- and 30-year real yields since July 2023:

As you can see, real yields peaked in October 2023 at a higher level than today’s market. The real yield curve at the time was essentially flat, with the entire maturity spectrum yielding in a range from 2.47% to 2.58%. That trend continued for about a month, before real yields began falling, fairly dramatically.

What’s interesting is that the September 2023 annual inflation rate (which was announced Oct. 12, 2023) came in at 3.7%, not much higher than today’s 3.5%.

Also at the time, the Federal Reserve was pushing the idea that short-term interest rates might not need to go any higher. And in fact, the Fed has held its federal funds rate in the range of 5.25% to 5.50% since July 2023. No cuts, no increases.

It was the Fed’s “no higher” message that helped cause interest rates to begin a steady decline into January 2024. In addition, the U.S. entered a mildly disinflationary trend through the end of 2023. As a result, real yields fell sharply through the end of the year:

But now, inflation is seemingly again a rising threat, and the Fed is hinting that it might need to increase interest rates if the trend continues. I think an increase is unlikely, but once-likely rate cuts might be out of the picture for the rest of 2024. Stock investors seem to be taking that news with a yawn, but the bond market is in turmoil, with the total bond market producing a total return of -3.0% year to date.

Here are how real yields stand today compared with their highs of October 2023:

As you can see, the 2023 yields were about 30 basis points higher than today’s elevated levels. October 2023 was a great month for building a ladder of TIPS investments, with all maturities yielding close to 2.5% above inflation. April 2024, in fact, is also an opportune time for making new TIPS investments.

But as this chart shows, real yields could go higher. Or, as happened in the months after October 2023, they could move sharply lower. A lot will depend on inflation trends and what actions the Fed decides to take through the end of the year … an election year.

What this means

I am always looking for a “new investing era” and I am certain we are well into an era of normalized interest rates, after a decade-plus of Federal Reserve actions to hold rates at ultra-low levels.

By historical standards, a 10-year Treasury note with a nominal yield of 4.67% and a 10-year TIPS with a real yield of 2.24% aren’t outliers. These were fairly normal in the past. In fact, the 10-year Treasury note had a nominal yield above 5% for nearly three decades from 1970 to 2000, as shown in this chart:

So are interest rates peaking in April 2024? My guess is: Probably. But it will depend on actions and direction from the Federal Reserve, which right now seems fairly happy with higher yields keeping the U.S. economy (and potentially inflation) under control.

Any change for I Bonds?

The Treasury will be resetting the fixed rate of the U.S. Series I Bond on Wednesday, May 1. The current fixed rate is 1.3%. That rate, which was the highest in 16 years, was set on Nov. 1, 2023, just after the October surge in real yields. The same thing is happening now, with a surge in April 2024.

My guess is that the Treasury will hold the I Bond’s fixed rate at 1.3%, and when combined with a new variable rate of 2.96%, I Bonds issued from May to October will be getting a composite rate of 4.27%, down from the current 5.27%.

Could the fixed rate rise, maybe to 1.4%? It could, if the Treasury attempts to factor in higher future real yields. Seems iffy to me.

The I Bond rate announcement could be coming on the morning of Tuesday, April 30, or more likely on the morning of Wednesday, May 1. TreasuryDirect has this message posted on a link from its homepage:

The current rate of 5.27 percent is available until 11:59 p.m. Eastern Time on Tuesday, April 30. The new rate becomes available at midnight.

That would seem to indicate TreasuryDirect will still be accepting orders for April I Bonds on Tuesday. But I would not risk that. If you are buying and want the higher April rate, buy Monday at the latest.

• Now is an ideal time to build a TIPS ladder

• Confused by TIPS? Read my Q&A on TIPS

• TIPS in depth: Understand the language

• TIPS on the secondary market: Things to consider

• Upcoming schedule of TIPS auctions

* * *

Posted in Federal Reserve, I Bond, Inflation, Investing in TIPS, Savings Bond, TreasuryDirect | 20 Comments

Let’s weigh in on the I Bonds vs. T-bills debate

Posted on April 21, 2024 by Tipswatch

By David Enna, Tipswatch.com

Last week I was being interviewed by CNBC’s Kate Dore about I Bond investment strategies, and I found myself asking her a question: “Do you think the Federal Reserve has learned a lesson?”

In other words, after a decade of manipulating the U.S. Treasury market and money supply, has the Fed really learned its actions can have dire consequences? We got a 40-year-high surge in inflation. Is the Fed done with all that?

We can’t know, of course. I asked this question because I have been getting a lot of feedback from readers and seeing heated discussions on the Bogleheads forum about this issue: Should I dump I Bonds to buy T-bills? It is a reasonable question because I Bonds with a 0.0% fixed rate will soon be earning 2.96% for six months. Even for new I Bonds, the May-to-October composite rate will fall to about 4.27% at a time when 4-week T-bills are paying 5.49%.

T-bills are going to have a 100-basis-point advantage over new I Bonds, and that is hard to ignore. For example, here are two perfectly logical comments from readers:

When interest rates were still very low, there was a 7.12%, 9.62% and then a 6.48% APR staring you right in the face. You’d be ignorant to not pounce on it. Add on the compounding interest and the money being safe, and you’re all set. However, the tide has turned and now I-bonds are still “okay” at 5.27% and 4.27% APR (average of 4.77%), but I can get a 4-week bond for 5.33% APR with no penalty and my money is available within 4 weeks.

And this:

Hard pass. This only makes sense if (1) fixed rate doesn’t go higher and (2) very long term. My savings accounts pay 5%+ and easy to lock 1-2 year CDs at 5-6%. Combine the 3 month penalty plus subpar 4.27% for 6 months and this is a loser.

These readers are thinking logically, because they are committed to investing for the short term, and as I noted in my recent article on the I Bond buying equation, I Bonds are no longer the most attractive investment for the short term.

But for the long term?

Over the last 13 years, even I Bonds with 0.0% fixed rates have greatly out-performed 4-week T-bills. Why? Because the Fed controls short-term interest rates, but has no actual direct control over U.S. inflation, which sets the I Bond’s variable rate. The results:

This gets back to my question: Has the Fed truly learned its lesson about manipulating the U.S. bond market? Will it now be unwilling to force nominal yields to close to zero and real yields below zero? I think it has, for the time being, and we won’t see ultra-low interest rates in the near future.

But what happens if the economy begins spiraling downward, or the banking system faces another crisis? Can the Fed resist the temptation to send interest rates tumbling and begin another phase of quantitative easing? Take a look at the Federal Reserve’s balance sheet of U.S. Treasurys since 2009:

From August 2019 to June 2022, the Federal Reserve’s balance sheet of Treasury holdings increased 175%. And this was the effect on the U.S. money supply, combined with very generous direct payments to U.S. taxpayers during the Covid crisis:

And finally, the effect of the Fed’s actions on U.S. inflation over the same period:

These charts are relevant because the Federal Reserve is now considering paring back quantitative tightening, meaning it will slow down reduction of its balance sheet, even though it remains double the size of the 2020 level. This is from a recent Reuters report:

The Fed is currently allowing up to $60 billion per month in Treasury bonds and up to $35 billion per month in mortgage bonds to mature and not be replaced as part of a process called quantitative tightening, or QT.

“Participants generally favored reducing the monthly pace of runoff by roughly half from the recent overall pace,” the minutes said.

Most Americans will have no idea of this change, which eventually should help bring longer-term interest rates a bit lower. And in due course, the Fed will begin gradually lowering short-term interest rates, which will get noticed. The process should be slow and careful, as long as the U.S. economy remains healthy.

For the near-term, T-bills are going to offer better yields than I Bonds. Short-term investors should favor T-bills if their investing horizon is 2 years or less.

Some readers have suggested: “Well, if the T-bill yield falls I will just jump back into I Bonds.” The problem, though, is the $10,000 per person limit on purchases. It takes a long time to build a sizable holding in I Bonds, unless you use complicated strategies like tax-refund paper I Bonds and purchases through gift-box, trusts, or business-owner strategies.

And to be clear, I love T-bills and have been using staggered rollovers of 13- and 26-week T-bills as an emergency cash holding for nearly two years.

But for the longer-term, I Bond still make sense. They protect against unexpected future inflation and unexpected future Federal Reserve manipulation. If we see ultra-low interest rates again, even 0.0% fixed-rate I Bonds are going to offer a return matching inflation and well above T-bills. Today, I Bonds are selling with a permanent fixed rate of 1.3%, the highest in more than 16 years.

Another viewpoint …

Here is a new video from Jim of the “I Was Retired” YouTube channel, addressing 5-year potential investments in Treasury notes, TIPS and/or I Bonds. The video is well organized and an accurate look at the three investments. (Another thing I really appreciate is that Jim has his liquor cabinet directly behind his filming stage. Yes, and I totally understand!):

• I Bond dilemma: Buy in April, in May, or not at all?

• Confused by I Bonds? Read my Q&A on I Bonds

• Let’s ‘try’ to clarify how an I Bond’s interest is calculated

• Inflation and I Bonds: Track the variable rate changes

• I Bonds: Here’s a simple way to track current value

• I Bond Manifesto: How this investment can work as an emergency fund

Posted in Cash alternatives, Federal Reserve, I Bond, Inflation, Treasury Bills, TreasuryDirect | 41 Comments

New 5-year TIPS gets a real yield of 2.242%, 2nd highest in 15 years

Posted on April 18, 2024 by Tipswatch

By David Enna, Tipswatch.com

The Treasury’s auction of $23 billion in a new 5-year Treasury Inflation-Protected Security — CUSIP 91282CKL4 — resulted a real yield to maturity of 2.242%, the 2nd highest result for this term since October 2008.

The coupon rate was set at 2.125%, the 2nd highest for this term since April 2006.

Earlier in the day, the most recent 5-year TIPS was trading on the secondary market with a real yield to maturity of 2.18%. This auction got a result 6 basis points higher, but it came in below the “when-issued” prediction of 2.27%, so demand was strong. The bid-to-cover ratio was 2.58, also indicating decent demand.

The April 5-year TIPS auction tends to get a real yield higher than the market established by the October version from the year earlier. That is because of the typical swoon in end-of-year non-seasonal inflation, which will hit right before this TIPS matures in 2029. More on that for nerds.

All those details aside, this is a good result for investors in today’s auction, with the real yield holding well above 2.0%. Here is the trend in the 5-year real yield over the last 3 years, showing the dramatic increase since spring 2022:

Pricing

Because the coupon rate for this new TIPS was set slightly below the real yield to maturity, investors got it at a discount.

Here is how the pricing would work out for an investor purchasing $10,000 par value of this TIPS:

Par value: $10,000
Inflation index on settlement date of April 30: 1.00309
Total principal purchased: $10,000 x 1.00309 = $10,030.90
Unadjusted price: 99.452867
Cost of investment: $10,030.90 x 0.99452867 = $9,976.02
+ accrued interest of about $8.74

In summary, the investor paid $9,976.02 for $10,030.90 of principal and will receive inflation accruals through the maturity date of April 15, 2029, plus twice-a-year coupon payments totaling 2.125%.

Inflation breakeven rate

With the nominal 5-year Treasury note yielding 4.68% at the auction’s close, this TIPS gets an inflation breakeven rate of 2.44%, about in the midrange of recent auctions of this term. This means it will outperform the nominal Treasury if inflation averages more than 2.44% over the next five years.

This chart shows the inflation breakeven trend over the last five years. Even though 2.44% is a high breakeven rate by historical standards, it is on the low end of more-recent trends as inflation has ramped higher.

Reaction to the auction

This one appears to have gone off as expected, with CUSIP 91282CKL4 getting the expected “April boost” in yield. Demand appears to have been solid. I was a buyer, adding to my 2029 holdings. This is from the Reuters report:

The results of the U.S. Treasury’s $23 billion auction of U.S. five-year Treasury Inflation-Protected Securities on Thursday were stronger-than-expected across almost all metrics. The note’s high yield stopped at 2.242%, lower than the expected rate at the bid deadline, which suggested that investors were willing to settle for a lower yield to take the security.

The bid-to-cover ratio, another measure of demand, was 2.58, slightly above the 2.55 seen in December, but much higher than October’s 2.38. The note’s bid-to-cover ratio was the highest since June 2022.

Here is a history of recent auctions of this term: