Want to ‘double dip’ your I Bond purchases? Act fast.

Posted on December 28, 2021 by Tipswatch

By David Enna, Tipswatch.com

U.S. Series I Savings Bonds are one of the nation’s most talked-about investments of 2021, especially now that their inflation-adjusted interest rate has surged to 7.12% at the November 1 reset. Glowing articles have been popping up in Barron’s, Bloomberg, the Wall Street Journal, CNBC, USA Today, and on and on.

And now, as the year draws to a close, there is a possibility to lock down — in a two-week period — $20,000 in I Bonds (or $40,000 for a couple) and get 7.12% annualized for a full six months on the entire investment. The Treasury sets a $10,000 per person per calendar year limit on I Bond purchases, but the 2021 purchase cap ends on Dec. 31 and the 2022 cap launches on Jan. 1.

So here you go, a chance to double up on a very attractive interest rate. But you will need to act fast.

What is an I Bond?

If you are totally new to I Bonds, you can read my “Q&A on I Bonds,” which covers all of the pluses and minuses of this investment. But briefly … An I Bond is a U.S. government security that earns interest based on combining a fixed rate and an inflation-adjusted rate.

  • The fixed rate will never change. So if you bought an I Bond in 2014 with a fixed rate of 0.2%, it will continue to have a 0.2% fixed rate for the life of the bond. Purchases through April 30, 2022, will have a fixed rate of 0.0%, which means they will simply track official U.S. inflation over time.
  • The inflation-adjusted rate (often called the variable rate) changes each six months to reflect the running rate of inflation. That rate is currently set at 7.12%, annualized, for six months. It will adjust again on May 1, 2022, for all I Bonds, no matter when they were purchased. (However, the effective start date of the new interest rate will vary depending on the month you bought the I Bond.)

I Bonds are the most conservative and most safe of all investments. Your principal is 99.9999999% safe and it will never decline, ever. If inflation falls to below zero, the inflation-adjusted rate will fall to zero, but not below zero.

The value of building and holding a stockpile of I Bonds has been demonstrated in 2021, with inflation surging to an annual rate of 6.8% in November. As U.S. inflation rises, the return on I Bonds increases, and the money compounds tax deferred until you redeem the I Bonds.

The purchase limit

Investments are limited to $10,000 per person per calendar year for electronic I Bonds held at TreasuryDirect. There is also the option to get $5,000 a year in paper I Bonds in lieu of a federal tax refund. Some investors find this amount too small to make a difference in their asset allocation. However, an investor using multi-year purchases can build a substantial stake in I Bonds.

And that’s why this last week in December is so important. This week, you can lock down $10,000 with a 7.12% return for the first six months and then next week, do it again. That is a total of $20,000 for a single person, and $40,000 for a couple. For most people, that is a significant investment, especially for use as part of an emergency fund.

After six months for each investment, on June 1 for the I Bonds bought in December and July 1 for the I Bonds bought in January, the inflation-adjusted variable rate will be reset. It’s impossible to say what that new rate will be, but I think it’s likely to be in a range of anywhere from 4% to 7% … also very attractive.

I Bonds have to be held a year before they can be redeemed and there is a penalty of the last three months of interest for I Bonds held less than 5 years. But even with that penalty, any purchase of I Bonds in December and January will be guaranteed to return at least 3.56% over one year. Compare that to an insured bank CD paying 0.60%, or the 1-year Treasury paying 0.33%. It’s no wonder I Bonds are a very popular investment at the moment.

Want to do this? Get started TODAY

To buy I Bonds, you need to have an account at TreasuryDirect. If you already have an account, no problem. Just log in and make the purchase. But if you don’t have an account, time is running out. You need to place your I Bond order today, Dec. 28 (preferably) or tomorrow (last shot), to ensure that your purchase will be registered in December 2021. A purchase made Thursday might be OK, but it’s getting risky.

A lot of readers don’t like TreasuryDirect, which can be a bit clunky. But the process of buying and redeeming I Bonds at TreasuryDirect works well. First you need to open an account, and I wrote a guide to walk you through the basics: Ready to open a TreasuryDirect account? Here are some tips.

When you set up the account, you will be linking a bank or brokerage account to TreasuryDirect. Then to buy I Bonds, you simply log into TreasuryDirect, set the purchase amount and date, and the purchase will be made. You can purchase I Bonds near the end of a month and get credit for a full month of interest. TreasuryDirect makes timing the purchase easy.

Couples need two separate TreasuryDirect accounts, so allow time for that if you are using this strategy.

Then … buy in January? Or later?

I’ll be writing a guide to I Bond purchases in 2022 next month, but right now I am thinking that a purchase in January will be fine. In reality purchasing any time through April 30, 2022, will ensure six months of the 7.12% rate. So there won’t be a similar rush to buy in January.

But if the idea of a “double dip” purchase of I Bonds appeals to you — along with a super-attractive interest rate over the next year — you need to get the 2021 purchase done … RIGHT NOW.

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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.

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.

Posted in Cash alternatives, I Bond, Savings Bond | 25 Comments

5-year TIPS reopening auction gets real yield of -1.508%

Posted on December 22, 2021 by Tipswatch

No surprises, but demand looked lukewarm

By David Enna, Tipswatch.com

The Treasury’s reopening auction of CUSIP 91282CDC2 — creating a 4-year, 10-month Treasury Inflation-Protected Security — generated a real yield to maturity of -1.508%, well off the record low for this maturity.

This TIPS carries a coupon rate of 0.125%, so buyers had to pay a lofty premium to balance off an auctioned real yield well below zero. The adjusted price was about $109.43 for about 101.19 in value, after accrued inflation is added in. This TIPS will carry an inflation index of 1.01192 on the settlement date of Dec. 31.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or in this case, below) inflation.

So, while investors at today’s auction got a real yield to maturity of -1.508%, that doesn’t mean they are accepting a negative nominal return. Instead, this investment will lag official U.S. inflation by 1.508% over the next 4 years, 10 months. If inflation averages 3.0% over that time, the nominal return will be about 1.49%. To put that in perspective, a 5-year Treasury note is currently yielding 1.22%.

The record low yield for this 4- to 5-year TIPS maturity was set at the originating auction for this TIPS, on Oct. 21, 2021, with a real yield to maturity of -1.685%.

Here is the trend for the real yield of a full-term 5-year TIPS over the last three years, as estimated by the U.S. Treasury, showing how real yields have been climbing slightly higher in the wake of Federal Reserve moves to scale down economic stimulus:

Inflation breakeven rate

With a 5-year nominal Treasury trading today with a yield of 1.22%, this TIPS gets a 5-year inflation breakeven rate of 2.73%, a bit below the Oct. 21 result of 2.89%. The breakeven rate means that this TIPS will outperform a nominal Treasury if inflation averages more than 2.73% over the next 4 years, 10 months.

A breakeven rate of 2.73% certainly looks fair, given that U.S. inflation is currently running at 6.8% and looks likely to maintain a high rate well into 2022.

Here is the trend in the 5-year inflation breakeven rate over the last three years, showing that while inflation expectations surged after the pandemic mania of March 2020, they have eased off recently in reaction to the Federal Reserve’s “hawkish” announcements:

Reaction to the auction

This TIPS had closed on the secondary market Tuesday with a real yield of -1.53%, so today’s auction result of -1.508% came in slightly higher, indicating lukewarm demand. The bid-to-cover ratio was 2.42, the lowest for the 10 most recent auctions of this term. Again, indicating lukewarm demand.

The TIP ETF, which holds the full range of maturities of TIPS, had been trading a bit higher all morning, indicating lower real yields. After the auction closed at 1 p.m. … nothing happened. It looks like the Treasury market was happy enough with the auction result.

This auction closes the history of CUSIP 91282CDC2, which did manage to set the record low yield for any TIPS of this term at its originating auction. The Treasury will offer a new 5-year TIPS in April, potentially very close to the Fed’s first moves to raise short-term interest rates. Let’s hope we see some more attractive TIPS offerings in 2022.

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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.

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.

Posted in Investing in TIPS | 1 Comment

5-year TIPS real yield will be omen of things to come

Posted on December 19, 2021 by Tipswatch

Treasury will reopen a 5-year TIPS at auction Wednesday, as real yields are creeping higher.

By David Enna, Tipswatch.com

The last TIPS auction of the year is coming Wednesday, a day early because of the holiday season, when the U.S. Treasury will offer $17 billion in a reopening of CUSIP 91282CDC2, creating a 4-year, 10-month Treasury Inflation-Protected Security.

This auction follows just a week after the Federal Reserve announced it will accelerate tapering of its bond-buying program, cutting its January purchases by $20 billion for Treasury securities and $10 billion for mortgage-backed securities. Federal Reserve Chairman Jerome Powell said Wednesday the bond-buying should end by March 2022:

“If the economy evolves broadly, as expected, similar reductions in the pace of net-asset purchases will likely be appropriate each month, implying that increases in our securities holdings would cease by mid-March, a few months sooner than we anticipated in early November. “

You’d think the end to Treasury purchases by the Fed would lead — at least — to a tick higher in real yields (meaning the yield TIPS provide above or below inflation) but this isn’t a sure thing. The Fed is likely to continue rolling over its past purchases, keeping its balance sheet stable. The Fed now owns well over 20% of the entire Treasury market, so its influence over future yields will continue, even without a bond-buying program. This Bloomberg chart shows the massive escalation of the Fed’s Treasury ownership over the last two years:

The point is: An end to the Fed’s bond-buying program will not end its dominance of the Treasury market. That will continue until the Fed begins shrinking its balance sheet, an event that could cause panic in the stock and bond markets. If you examine that chart, you can see that despite the tapering event of 2014, the Fed’s balance sheet remained stable until well into 2017.

But hey, we have actually seen 5-year real yields tick higher this month, possibly triggered by the Fed’s other announcement: That is is preparing to raise short-term interest rates in 2022, potentially three times to range of 0.75% to 1.00%. The 5-year TIPS is the maturity most sensitive to increases in the Federal Funds Rate. Here is the trend we’ve seen, using Treasury estimates of 5-year real yields:

  • Aug. 1. 5-year real yield -1.85%
  • Sept. 1. -1.70%
  • Oct. 1. -1.58%
  • Nov. 1. -1.66%
  • Dec. 17. -1.47%

Another reason for the tick higher in the 5-year real yield is that inflation expectations are falling, slightly, in reaction to the Fed’s hawkish stance. That means real yields have room to move higher as nominal rates also increase. Sometime in the near future, will we see a strong surge to higher real yields, as we did in the two years from December 2012 to December 2014?

Notice that the 5-year yield started that period at -1.44%, very close to where it is today, and ended the period at 0.46%, 190 basis points higher. And this happened a full year before the Fed began raising the Federal Funds Rate in December 2015. The funds rate didn’t reach 0.75% — where it is expected to be next year — until March 2017. All of this shows the accelerated path today’s Fed is taking under our current threat of looming inflation.

Just out of curiosity, I looked to see where the 5-year real yield was on March 16, 2017, just after the Fed’s third rate increase in that tightening cycle:

  • 5-year TIPS: 0.18%
  • 5-year Treasury note: 2.05%
  • 5-year inflation breakeven rate: 1.87%

Clearly, we should be seeing higher real yields in coming months, making TIPS more attractive. The 5-year TIPS will be the most sensitive, rising the fastest in the wake of Fed actions. Longer-term real yields, however, could be suppressed as fears of recession rise and the yield curve flattens.

Wednesday’s reopening auction

Oh, well, back to the mundane reality of Treasury auctions. CUSIP 91282CDC2 trades on the secondary market, so you can check its current real yield to maturity and price on Bloomberg’s Current Yields page. As of Friday’s market close, it was trading with a real yield of -1.54% and price of about $108.36 for $100 of value.

A TIPS is an investment that pays a coupon rate well below that of other Treasury investments of the same term. But with a TIPS, the principal balance adjusts each month (usually up, but sometimes down) to match the current U.S. inflation rate. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above (or in this case, below) inflation.

CUSIP 91282CDC2 has a coupon rate of 0.125% but a real yield to maturity of -1.54%, so investors have to pay about an 8.4% premium to par value to purchase this TIPS. In addition, it will have an inflation index of 1.01192 on the settlement date of Dec. 31, meaning investors will be buying an additional 1.19% in principal over par.

So, add this up. An investor putting in an order for $10,000 of this TIPS will actually be purchasing $10,119 in principal. Tack on the 8.4% premium, and the adjusted cost of this investment will be about $10,969 for $10,119 in principal.

Of course, real yields can change before Wednesday’s auction closes at 1 p.m. EDT. If you are investing in this TIPS auction, keep an eye on Bloomberg’s Current Yields page, which shows real-time trading.

Here is the trend in 5-year real yields over the last five years, showing how real yields have been creeping higher since mid November:

Inflation breakeven rate

With a 5-year nominal Treasury currently trading with a yield of 1.17%, this TIPS currently has a five-year inflation breakeven rate of 2.71%, which seems like a reasonable number. Here is the trend in the 5-year inflation breakeven rate over the last five years, also showing how inflation expectations have been waning a bit as the Fed prepares to ease off on economic stimulus:

Conclusion

I was a buyer at only one TIPS auction this year, on June 17 when a 5-year reopening got a real yield to maturity of -1.416%, which seemed “decent” at the time. Wednesday’s auction could see a real yield rising to that level; it will depend on investor demand. I’m not particularly interested this time around, however, because I see the potential for higher real yields in the future.

OK, full disclosure, my track record as a “predictor of the future” is pretty poor. I will be reporting the auction results soon after the close at 1 p.m. Wednesday.

As a side note, if you haven’t purchased your full allocation of U.S. Series I Bonds this calendar year — $10,000 per person — you should do that before you invest in a 5-year TIPS. The I Bond is clearly the better investment, with a 150-basis-point advantage over a 5-year TIPS.

Here’s a history of recent TIPS auctions of this term:

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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.

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.

Posted in Investing in TIPS | 1 Comment

U.S. inflation surged 0.8% in November, as prices rise at the highest rate in 39 years

Posted on December 10, 2021 by Tipswatch

By David Enna, Tipswatch.com

This time, the economists just about got it right.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.8% in November on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 6.8%, the largest 12-month increase in more than 39 years, since the period ending June 1982.

Those numbers came close to matching the consensus forecasts of 0.7% for the month and 6.8% for the year, so these increases shouldn’t surprise the stock and bond markets. (S&P 500 futures are up nicely in premarket trading this morning.) In recent months, economists have been woefully underestimating U.S. inflation. I think they’ve gotten the memo: Inflation is here, with a vengeance.

Core inflation, which strips out food and energy, came in at 0.5% for the month and 4.9% for the year, matching consensus estimates. That annual rate is the highest for core since 1991.

The BLS noted that the November surge in inflation was due to broad price increases across the economy, with the indexes for gasoline, shelter, food, used cars and trucks, and new vehicles among the larger contributors. For example:

  • Gasoline prices were up a strong 6.1% for the month, and are now up 58.1% over the last year.
  • The costs of food at home rose a painful 0.8% in November, after rising 1.0% in October and 1.2% in September. The BLS said prices increased in all six major grocery store indexes. Overall, food costs increased 6.1% over the last year.
  • Prices for used cars and trucks increased 2.5% for the month, matching the October increase, and are now up 31.4% over the last year. Prices for new vehicles were up 1.1% for the month.
  • Shelter costs rose 0.5% for the month, and are up 3.8% over the last year.
  • Apparel costs rose 1.3% in November, and are up 5.0% over the last year.
  • The costs of medical care services increased 0.3% for the month and are up a moderate 2.1% for the year.

While gasoline is often a major factor in rising U.S. inflation, the November report demonstrates that prices are surging across most key areas of the U.S. economy: Food, shelter, transportation, clothing. Here is the 12-month trend for all-items and core inflation, showing the stunning surge higher beginning in March 2021:

Because of the relatively low annual inflation indexes for December 2020 to March 2021, it’s clear that official U.S. inflation could continue running “hot” well into 2022, before possibly moderating in the spring and summer months.

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 for TIPS and set future interest rates for I Bonds. For November, the BLS set the inflation index at 277.948, an increase of 0.49% over the previous month.

For TIPS. The November inflation report means that principal balances for all TIPS will increase 0.49% in January, following an increase of 0.83% in December. TIPS principal balances will be up 6.8% for the year ending in January. Here are the new January Inflation Indexes for all TIPS.

For I Bonds. November inflation was the second in a six-month string, from September 2021 to March 2022, that will determine the I Bond’s next inflation-adjusted variable rate, which will be reset May 1. Two months into this period, inflation has increased 1.33%, which would translate to a variable rate of 2.66%. Four months remain, and a lot can happen in four months.

Here are the numbers so far:

I Bonds currently offer a composite rate of 7.12%, annualized, for six months, and are on track to have another very attractive rate at the May 1 reset. If you haven’t bought a full allocation of I Bonds this year — $10,000 per person per calendar year — try to get that done by Dec. 31. The purchase cap will reset on January 1, allowing another $10,000 per person purchase.

What this means for future interest rates

There was a lot of talk this week on CNBC that the November inflation report could push U.S. inflation above 7.0%. That was classic “managing expectations.” Instead, inflation came in close to the consensus estimates, and even though 6.8% inflation is unsustainable, Wall Street can let out a sigh.

Because prices are increasing across a wide spectrum of the U.S. economy, and this trend looks likely to continue for several months, the Federal Reserve will continue be under pressure to “look like” it is working to control inflation. That will mean speeding up a reduction of its bond-buying quantitative easing, and eventually, increases in short-term interest rates.

Every month U.S. inflation continues to rise to 39-year highs, we get two months closer to increases in short-term interest rates. Could we see three rate increases in 2022, putting the federal funds rate to a somewhere above 0.75%? This seems highly possible, and reasonable.

Here are some thoughts from “Inflation Guy” Michael Ashton, posted this morning on Twitter:

So wrapping this up…what does this mean for the Fed? In the Old Days, the Fed by now would have already tightened a bunch. Currently, we’re talking about reducing the amount they add in liquidity, maybe a little faster. And possibly raising rates in 2022.

That is, UNLESS stocks drop like a stone. And honestly, it’s not really clear to me that the government would care to see much higher interest costs on the debt. Only way Japan has survived its mountain of debt is that is it almost interest-free, after all.

But maybe the hawks will storm the Eccles Building and the Fed will not only raise rates, but also slow money growth (these were once tightly connected; now not so much, and it’s the money growth part that matters not the interest rate part). We can hope.

More on I Bonds:

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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.

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.

Posted in I Bond, Inflation, Investing in TIPS, Savings Bond | 7 Comments

When is the I Bond’s fixed rate likely to rise?

Posted on December 5, 2021 by Tipswatch

Yes, there is a slim chance we could see a higher fixed rate in 2022. But next year’s investors may still want to invest in I Bonds before May 1, to lock in the current 7.12% variable rate for six months.

By David Enna, Tipswatch.com

See my April 24 update on this topic: Let’s handicap the I Bond’s fixed-rate equation

The Federal Reserve last month began tapering its bond buying stimulus program, and hinted that it might begin raising short-term interest rates in 2022, well ahead of the expected schedule. The reason? Dangerously high inflation continues to entangle itself into the U.S. economy.

Federal Reserve Chairman Jerome Powell made clear this week in testimony to Congress that inflation has been stronger than the Fed expected, and is running at a pace (an annual rate of 6.2%) that cannot be maintained. Among his comments:

“It’s difficult to predict the persistence and effects of supply constraints, but it now appears that factors pushing inflation upward will linger well into next year. …

“Generally the higher prices we’re seeing are related to the supply and demand’s imbalances that can be traced directly back to the pandemic and the reopening of the economy. But it’s also the case that price increases have spread much more broadly in the recent few months across the economy, and I think the risk of higher inflation has increased. …

“Inflation has run well above 2% for long enough that if you look back a few years, inflation averages 2%. … So I think the word transitory has different meanings to different people. To many, it carries a sense of short lived. We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”

Powell’s admission that our current surge in inflation won’t be short-lived is a key concession, after months of claims the inflationary surge would be “transitory.” The result of this concession should be reflected in Fed policy: 1) quantitative easing through bond buying should be scaled back quickly, and 2) short-term interest rates should begin to rise by mid-year in 2022. Both of these actions, however, could roil the stock and bond markets, as we have seen in the last week.

Eventually, both real and nominal interest rates should begin rising, ending nearly two years of absurdly low rates, at a time when inflation has surged to a 30-year high. Finally, will investors see a reasonable return on safe investments? That’s my hope.

That brings us to the question: If the Fed truly does begin changing course (despite the likely stock market turmoil that will result) when is the Treasury likely to begin lifting the fixed rate of the U.S. Series I Bond above 0.0%, where it has remained since May 2020?

The all-important fixed rate

Even though newly issued Series I Savings Bonds currently have a fixed rate of 0.0%, they remain the most attractive very safe investment in the world. Because of the I Bond’s inflation-adjusted variable rate, investors buying I Bonds in December will earn 7.12% annualized interest for six months … and at least 3.56% over the next year (probably much higher, but that’s the worse-case scenario). Compare that to the current yield of a 1-year Treasury: 0.26%.

At this point, I Bonds don’t need a higher fixed rate to be attractive. Consider this: An investor buying the $10,000 per person per year limit in December would earn $356 in interest in the first six months. That is the equivalent of more than 17 years of interest from a fixed rate of 0.2%. For this reason, it will be almost impossible to justify not buying your 2022 allocation of I Bonds before May 1, even if you think the fixed rate will tick higher on May 1. You’ll want to lock in that 7.12% for six months.

But for investors looking to hold I Bonds as a long-term investment, a higher fixed rate is always attractive. The higher, the better.

After the Federal Reserve begins pushing short-term interest rates higher (possibly in mid 2022), what are the chances we will see a higher fixed rate for the I Bond? Let’s take a look back at the Fed’s last “tightening” period, which began with hints of tapering in 2013, followed by a tapering launch in January 2014 and then finally, in December 2015, actual increases in the the Federal Funds rate.

It’s surprising to remember that the I Bond’s fixed rate rose to 0.2% in November 2013, more than two years before the Fed began raising short-term interest rates.

Based on this “past performance,” we can surmise that maybe the Federal Funds rate has little to do with real yields in general, or the I Bond’s fixed rate in particular. And that is true. Real yields (meaning yields above inflation, or currently, below inflation) are much more a factor of market sentiment. I contend that the I Bond’s fixed rate generally tracks 50 to 60 basis points below the real yield of a 10-year TIPS. At this point, a 10-year TIPS has a real yield of -1.08%, meaning the I Bond currently has a yield advantage of 108 basis points. Under these circumstances, there is very little chance the Treasury would raise the I Bond’s fixed rate above 0.0%.

So, for the I Bond’s fixed rate to rise, 10-year real yields are going to have to climb dramatically higher, probably at least 125 basis points from today’s level. But, that isn’t really possible in 2022, is it? Actually, it is possible, as demonstrated dramatically in the Fed’s last tightening period beginning in 2013:

Note that the 10-year real yield rose a remarkable 181 basis points in the period from December 2012 to September 2013, even though the Federal Reserve 1) hadn’t even started tapering its bond purchases and 2) was still more than two years away from its first increases in short-term interest rates.

This next chart compares rate trends for the I Bond’s fixed rate, the Federal Funds rate and the 10-year real yield over the last 10 years (click on the image if you want to see a larger version):

Note that in most cases through the decade, 10-year real yields rose and fell before the Fed took action to raise or cut short-term interest rates, and the I Bond’s fixed rate rose and fell as a lagging indicator of 10-year real yields. This makes sense because the I Bond’s fixed rate is changed only twice a year: On May 1 and November 1. The Treasury makes that rate decision based on rate trends for weeks or months leading up to the reset.

When the 10-year real yield surged higher throughout 2013, the Treasury reacted with a 0.2% fixed rate in November 2013. When the 10-year real yield started slipping lower in 2016, the Treasury returned the I Bond’s fixed rate to 0.0% through November 2017. After the 10-year real yield surged to a multi-year high in late 2018, I Bonds got a fixed rate of 0.5% for a year.

A higher fixed rate is possible in 2022

To be clear, the Treasury has no announced formula for setting the I Bond’s fixed rate, and everything you just read is informed speculation. The Treasury sometimes does weird things.

To get to a higher fixed rate, it’s going to take a mighty surge in real yields, but the example of 2013 shows that this kind of surge is possible when the Fed takes away the easy money punch bowl. The difference this time, however, is that the Fed has stated clearly that it will begin scaling back its bond buying, and real yields have barely budged. The 10-year real yield — now at -1.08% — remains close to its 2021 low of -1.19%, set on Aug. 30.

My guess is that the I Bond’s fixed rate will remain in a range of 0.0% to 0.2% through 2022. Will the fixed rate rise at or before the November 1 reset? I’d put the odds at about 15%, and that would take a giant move higher in real yields. But hey, I could be wrong.

Final thought: Can you really pass up 7.12% for six months?

Timing your I Bond investments in 2022 will take some serious thought. Will you wait it out for the chance of a higher fixed rate? I think a lot of I Bond investors will be tempted to do that. Or will you simply take the bird in the hand — a 7.12% return for six months? It will be there for the taking in January, when a new $10,000 per person purchase cap sets in.

My opinion: Waiting until mid April 2022 to make an I Bond purchase will make sense, because by then you will know the I Bond’s next variable rate, and there’s always the slim possibility that real yields will rise by 100+ basis points. But realistically, waiting until May and beyond probably won’t make sense, because as I noted earlier, the six-month return on 7.12% will be equal to more than 17 years of a 0.2% fixed rate.

Of course, the variable rate reset on May 1 could be near 7.12% or even surpass it. But remember, when you invest in an I Bond, you get the current variable rate for a full six months, and then all future variable rates will follow for six months each. Buying before May 1 looks like the logical choice.

I’ll be writing more on this topic early next year.

More on I Bonds:

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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.

Posted in I Bond, Inflation, Savings Bond | 38 Comments