Should the Treasury raise the I Bond purchase cap to $100,000?

Posted on February 22, 2022 by Tipswatch

An op-ed piece in today’s Wall Street Journal makes the case.

By David Enna, Tipswatch.com

Probably the most-often-mentioned “negative” of the U.S. Series I Savings Bond is the purchase cap of $10,000 per person per calendar year, plus the option of $5,000 in paper I Bonds in lieu of a federal tax refund. A lot of investors look at that limit and brush the attractive investment aside as “insignificant.”

And that’s true if you are sitting on a multi-million-dollar portfolio and looking to make a one-time investment in I Bonds. That $10,000 or even $15,000 will barely budge your asset allocation.

That’s why I have argued for years that the Treasury’s purchase cap requires an investor to buy I Bonds year after year, up to the cap if possible, to build a sizeable allocation in inflation protection. This strategy means buying even if the fixed rate is 0.0% and the inflation-adjusted variable rate is 0.16%, as we saw through six months of 2016. (Those 2016 I Bonds will be paying 7.12% annualized this year for six months, just like the “very attractive” I Bonds you can purchase today.)

I Bonds are getting a lot of attention right now, thanks to that 7.12% annualized rate, which is likely to remain quite high throughout 2022 and into 2023. According to the Wall Street Journal, over the past three months I Bond purchases have soared to $7.1 billion, compared with an average of $700 million a year during the decade before.

But, here’s the question: Should the Treasury raise the purchase cap? Absolutely.

When I Bonds were first created in the fall of 1998, the purchase limit was $30,000 per person per year, and the Treasury even allowed credit cards to be used for purchases with no fees. (Air miles!) However, according to Finweb.com, the Treasury determined about 98% of all savings bonds were purchased in amounts under $5,000. This triggered a new policy in 2008: a $5,000 limit per calendar year.

The current limit of $10,000 per person per calendar year went into effect in January 2012, when the Treasury required I Bonds to be purchased in electronic form at TreasuryDirect, except for the $5,000 option as a tax refund. So the current cap has been in effect for a decade, with no adjustments for inflation over that time. It takes $12,400 in today’s dollars to match the buying power of $10,000 in January 2012.

So yes, the Treasury should immediately raise the purchase cap on I Bonds to allow Americans to protect more of their savings from surging inflation. I’ve suggested doubling the amount to $20,000 per year (or $40,000 for a couple). And maybe at the same time eliminate the $5,000 tax refund option, which is probably a logistical nightmare for the IRS and Treasury.

A much more dramatic proposal

The Wall Street Journal today carried an op-ed piece by Joshua Rauh (a senior fellow at Stanford University’s Hoover Institution) and Kevin Warsh (a former member of the Federal Reserve Board and visiting fellow at Hoover). They argue that surging inflation is becoming a “menace” that requires decisive action:

“President Biden, by executive order, should immediately direct Treasury Secretary Janet Yellen to raise the annual cap on Series I savings bonds from $10,000 to $100,000. … The executive order should also make clear that the higher purchase cap would fall when price stability is re-established, as certified by the Fed. …

“If the revamped I-bond program grew in popularity, the government would accrue higher funding costs. That’s part of the point. The government should internalize the budgetary and reputational costs of its policy errors. … Inflation’s 40-year hiatus from history is over. Errant monetary and fiscal policy decisions are to blame.”

Clearly, this proposal has a strong political spin, but it is hard to disagree with the theory that excessive monetary policy (by the Federal Reserve) and fiscal policy (by Congress) have sent inflation surging to a 40-year high.

My initial thought, however, is that raising the purchase limit to $100,000 temporarily would be a financial windfall for more wealthy Americans, allowing a couple to sock away $200,000 earning 7.12% interest as a short-term investment. Would these wealthy investors jump into — and then out of — I Bonds when yields fall in the future? Very likely.

I’d prefer to see the I Bond purchase limit increase to $20,000 per person per year permanently, and then be indexed to inflation (possibly in $500 increments). Or … even better … raise the limit to $30,000 as it was when the I Bond launched in 1998. (Can we also use credit cards for purchases with no fees? OK … let’s not get greedy.)

If you want to know more about how I Bonds work as investment, check out these pages on my site:

I Bond Manifesto: Using I Bonds as part of your emergency fund

Q&A on I Bonds: The way I Bonds work

Inflation and I Bonds: Tracking the I Bond’s variable rate

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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, Savings Bond | 56 Comments

New 30-year TIPS auctions with a real yield of 0.195% to seemingly weak demand

Posted on February 17, 2022 by Tipswatch

By David Enna, Tipswatch.com

Despite a flight to safety sending yields downward in the Treasury market, a new 30-year Treasury Inflation Protected Security auctioned Thursday with a higher-than-expected real yield to maturity of 0.195%, the first positive real yield for any TIPS at auction in nearly two years.

This is CUSIP 912810TE8, which received a coupon rate of 0.125% based on the auction results. So today’s investors got another thing they haven’t seen in nearly two years: A TIPS auctioning with a discounted price, because the real yield to maturity was higher than the coupon rate. The adjusted price was about $98.10 for about $100.14 of value, after accrued inflation is added in. This TIPS will have an inflation index of 1.00142 on the settlement date of February 28.

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 current U.S. inflation. So the “real yield to maturity” of a TIPS indicates how much an investor will earn above inflation.

The last time a TIPS auction of any term got a positive real yield was for a 10-year reopening auction on March 19, 2020, amid a day of near-complete market chaos because of pandemic fears. A few days later, the Federal Reserve launched an aggressive campaign to stabilize the Treasury market, sending real yields deeply negative.

While the market had been signaling that this new TIPS would get a positive real yield, the auction result was still a surprise. At 11:10 a.m. EST, a 29-year, 6-months TIPS was trading on the secondary market with a real yield to maturity of 0.10%. After the auction’s close, that yield increased to 0.18%, a pretty impressive move higher.

Obviously, investors in this new issue wanted higher-than-market yields, and the auction delivered. The bid to cover ratio was 2.17%, a low number that also indicates weak demand.

Here is the trend in 30-year real yields over the last 11 years, dating back to before an earlier phase of Federal Reserve quantitative easing, which began in spring 2011:

This chart might tell us where real yields could be heading in coming years. Note how in 2013 30-year real yields surged higher, because the Fed raised the possibility of tapering its bond-buying program, which didn’t actually begin until early 2014. Yields began declining in 2019, as the Fed started easing off on tightening.

The difference in 2022 is that the Fed is signaling an accelerated schedule: It could begin raising short-term interest rates and gradually reducing its balance sheet within a month. In that scenario, real yields should be climbing higher, and that was probably the message the market was sending today.

Inflation breakeven rate

With a 30-year nominal Treasury trading today with a yield of 2.30%, this new TIPS gets an inflation breakeven rate of 2.11%, on a par with recent auctions of this term. Clearly, investors are not foreseeing unusually high inflation over the next three decades, despite the current surge to 7.5% in January 2022.

For investors in today’s auction, an inflation breakeven rate of 2.11% looks like a positive. Here is the trend in the 30-year inflation breakeven rate over the last 11 years:

While the 30-year inflation breakeven rate surged strongly after March 2020, with the beginning of aggressive economic stimulus by Congress and the Federal Reserve, it has now settled into a “normal range” based on historical standards.

Reaction to the auction

The TIP ETF — which holds the full range of TIPS maturities — had been trading higher all morning, indicating lower real yields. But after the auction’s close at 1 p.m. EST, prices quickly dipped, indicating a negative reaction to the auction. Since then, however, the TIP ETF has stabilized.

Investors saw a similar reaction in LTPZ, Pimco’s 15+ Year U.S. TIPS ETF. Two minutes before the auction’s close, it was trading at $80.98 a share, but four minutes later had fallen to $79.68, a drop of 1.6% in the blink of an eye.

A 30-year TIPS isn’t a highly desirable investment for small-scale investors, Non-competitive bids amounted to only $14 million of the total of $9 billion auctioned Thursday. So today’s auction showed that the market’s big money — hedge funds, pensions funds, sovereign banks — are looking for higher yields. That could be continuing trend.

The Bloomberg report on the auction theorized that a “hawkish shift by the Federal Reserve is dashing demand for inflation-indexed Treasuries.”

The auction went begging “because when the Fed hikes, their primary goal is to move long-end real rates higher,” said Gang Hu, managing partner at Winshore Capital Partners LP. “Yes, we have moved them higher by a fair amount, but to be long them is to fight the Fed.”

CUSIP 912810TE8 will be reopened at auction in August. Here’s a recent history of TIPS auctions with 29- to 30-year terms:

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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 | 10 Comments

30-year TIPS auction could break through negative real-yield barrier

Posted on February 13, 2022 by Tipswatch

The Treasury will offer $9 billion in a new 30-year TIPS at auction Thursday. Here’s what to expect.

By David Enna, Tipswatch.com

It’s been two years since we’ve seen any TIPS auction, of any term, generate a real yield to maturity higher than zero. But that could change Thursday, when the Treasury auctions $9 billion in a new 30-year Treasury Inflation-Protected Security, CUSIP 912810TE8.

The coupon rate and real yield to maturity will be set by the auction, which closes at 1 p.m. EST Thursday. But we can get a pretty good idea where this auction is heading: The coupon rate will almost certainly be set at 0.125%, the lowest the Treasury will go for any TIPS. And the real yield to maturity has a decent chance of rising above zero, making this the first TIPS auction since February 2020 to get a positive real yield.

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 inflation.

The U.S. Treasury issues an estimate of the real yield of a full-term 30-year TIPS each day after the market closes. On Friday, this estimate was 0.09%, up 45 basis points since the beginning of the year. A lot could change over the next week (for example, in the Ukraine), but for now, it looks like this auction has a good chance of generating a positive real yield, meaning a yield that will exceed official U.S. inflation over the next 30 years.

Here is the trend in the 30-year real yield over the last two years, a period that began before the pandemic-caused market panic of March 2020 and continued through two years of aggressive economic stimulus by both Congress and the Federal Reserve:

In recent months, as the Federal Reserve has indicated it will end its bond-buying quantitative easing in March, 30-year real yields have been rising steadily, but still remain below pre-pandemic levels. My opinion is that a “normalized” 30-year real yield would be in the range of 1.0% to 1.5%, and even that is low by historical standards. So these long-term real yields have room to rise, if the economy remains strong and the Federal Reserve begins reducing its massive balance sheet of Treasurys.

However, if the U.S. economy shows any sign of weakness, I’d expect long-term real yields to be depressed by a flattening yield curve. But they should still be positive, offering a return above inflation.

Even if it gets a yield positive to inflation, CUSIP 912810TE8 could still end up auctioning with a slight premium price, because the real yield will still be below the coupon rate of 0.125%. Most likely, that premium will be about 1% above par, if the real yield holds at 0.09%. However, this TIPS will carry an inflation index of 1.00142 on the settlement date of Feb. 28. This means investors could end up paying about $101.14 for about $100.14 of value, after accrued inflation is added in. That’s a rough estimate!

Inflation breakeven rate

With a 30-year Treasury bond trading at 2.24% at the market close Friday, a new 30-year TIPS would have an inflation breakeven rate of 2.15%, which seems reasonable. That means this TIPS would outperform a nominal 30-year Treasury if inflation averages more than 2.15% over the next 30 years.

An inflation breakeven rate of 2.15% is in line with 30-year TIPS auctions back in 2017 and 2018, when U.S. inflation was running at about 2.0%. Now that number is a much-more threatening 7.5%. But the financial markets don’t seem worried, and don’t this trend continuing over 30 years. In fact, markets are predicting inflation at a very moderate rate. We’ll see.

Here is the trend in the 30-year inflation breakeven rate over the last 2 years, showing that long-term inflation expectations have stabilized and even declined slightly over the last year:

Thoughts on this auction

I’ve made it clear for years that I am not a fan of 30-year TIPS with real yields this low. This is a highly volatile investment, and a move of 50+ basis points higher, as we have seen in just the last three months, can reduce the market value of a 30-year TIPS by 15%. For example, a 30-year TIPS reopening auction last August had a premium price of about 12.8% above par value, or $112.84 for $100 of value. Today that same TIPS has a market value of $101.50, meaning it has lost more than 10% of its value in just six months.

Of course, volatility can work both ways, and if you are interested in trading TIPS as a speculative investment, a 30-year TIPS can be attractive. Otherwise, the very long term and high volatility make it unattractive for me. Just my opinion.

30-year TIPS versus a 30-year I Bond

So, if this new 30-year TIPS gets a real yield to maturity slightly higher than zero, does it become more attractive than a U.S. Series I Bond, with a fixed rate of 0.0%? I’d say no. I Bonds have several key advantages over a TIPS:

  • The holding term of an I Bond is flexible, anywhere from 1 year (with a three-month interest penalty), to 5-plus years with no penalty, all the way to 30 years when they reach final maturity.
  • An I Bond will never go down in value during a time of deflation, while a TIPS will lose accrued principal during deflationary times.
  • Interest earned on an I Bond can be deferred until it is sold or matures. For TIPS, both the coupon payment and inflation accruals are taxable in the current year. This “phantom income” makes a 30-year TIPS very unattractive for holding in a taxable account.
  • I Bonds have an advantage in the way their interest is compounded, since it all gets compounded. With a TIPS, the coupon rate is paid out as current income and is therefore not compounded (but could be reinvested elsewhere).

My feeling is that I Bonds — at this point — remain more attractive than any TIPS of any maturity. My view would change if we see real yields on 5- and 10-year TIPS climb well above zero. But at this point, I Bonds up to the purchase limit of $10,000 per person per year should be your first money invested in inflation protection.

Auction details

Thursday’s auction will close to non-competitive bids — like those made at TreasuryDirect — at noon EST and then finalize at 1 p.m. EST. If you are purchasing this TIPS in a brokerage account, be aware than auction purchases might be closed by 10 a.m. the day of the auction, or even earlier.

I will be reporting the auction results soon after the close. Here’s a listing of recent 29- to 30-year TIPS auctions, showing that the string of three consecutive negative yields is actually an aberration for this term, even during earlier times of Federal Reserve quantitative easing:

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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, Investing in TIPS | 2 Comments

Podcast: ‘The Inflation Guy’ analyzes the January inflation report

Posted on February 11, 2022 by Tipswatch

‘Too much money chasing too few goods.’ Economists don’t like it, it’s too simple, but it’s still the best explanation out there.

Tipswatch.com

Another month, another inflation shocker. What does it all mean?

Let’s get some answers from inflation guru Michael Ashton and his “Cents and Sensibility” podcast. I am a fan of this podcast and Ashton’s work because he has deep knowledge of how inflation works, but can explain complex issues in an entertaining way.

Ashton points out in January there were 10 price categories that inflated at an annualized monthly pace of at least 10%. So why are we still having a debate about “ongoing inflation” — the permanence, causes and symptoms of the nation’s surging prices?

His podcast intro: “Core CPI above 6%; headline at 7.5%. 40-year high after 40-year high. What is the ‘ongoing inflation debate’? The answers here are pretty simple. If you want fewer birds in your backyard, quit throwing birdseed out there.“

Have a listen:

Inflation Guy Podcast
https://inflationguy.podbean.com/e/ep-20-this-month-s-cpi-report-the-ongoing-inflation-debate/

You can subscribe to this podcast in all the traditional ways, or find it here.

Follow Ashton on Twitter at: https://twitter.com/inflation_guy

Who is Michael Ashton?

His audiences know him as the “Inflation Guy.” He is a pioneer in the U.S. inflation derivatives market. Before founding his company, Enduring Investments, Ashton worked in research, sales and trading for several large investment banks including Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003, when he traded the first interbank U.S. CPI swaps, and 2004 when he was the lead market maker for the CME’s CPI Futures contract, he has played an integral role in developing new instruments and methods for accessing and hedging various inflation exposures. In 2016, Mr. Ashton published What’s Wrong With Money? The Biggest Bubble of All. He is a graduate of Trinity University and lives in Morristown, New Jersey.

Have a question? Get the Inflation Guy app in the Apple App Store or Google Play, or email InflationGuy@enduringinvestments.com.

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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 Inflation | 5 Comments

U.S. inflation surged 0.6% in January, again higher than expectations

Posted on February 10, 2022 by Tipswatch

Inflation is running at a 40-year high. What does it mean for I Bonds, TIPS and future interest rates?

By David Enna, Tipswatch.com

Once again, U.S. inflation is running higher than expectations, a trend that will probably continue through the early months of 2022.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6% in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all-items index increased 7.5%, the largest 12-month increase in 40 years, since the period ending February 1982.

Both the monthly and year-over-year increases exceeded economist expectations of 0.5% for the month and 7.3% for the year. Core inflation, which removes food and energy, also exceeded expectations, running at 0.6% in January (versus expectations of 0.5%) and 6.0% for the year (versus 5.9%). The year-over-year number for core was the largest 12-month change since the period ending August 1982.

And this jump higher in inflation came despite the fact that gasoline prices actually fell in January, a trend that is likely to reverse in coming months. The BLS noted that a wide range of price increases contributed to January’s surge in inflation. Some highlights:

  • Food-at-home prices increased a troubling 1% in the month, and are now up 7.4% over the last year.
  • Gasoline prices fell 0.8% for the month, but are up 40% over the last year. This decline is highly likely to reverse in future months, as the price of WTI Crude has increased about 35% in the last two months.
  • Shelter costs rose 0.3% for the month, and are up 4.4% over the last year. This is another category where higher prices can be expected into the future.
  • Costs of electricity surged 4.2% in the month and are up 10.7% year-over-year.
  • Apparel prices, once a sleepy sector in the CPI report, were up 1.1% in January.
  • Prices for used cars and trucks continued surging higher, up 1.5% in the month and 40.5% for the year.
  • New car prices held stable, but are up 12.2% for the year.
  • The medical care index rose 0.7% for the month.

To wrap things up, the BLS said this: “The increase is broad-based, with virtually all component indexes showing increases over the past 12 months.”

Here is the one-year trend for all-items and core inflation, showing the remarkable climb higher from very low levels of inflation in January 2021:

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 on TIPS and set future interest rates for I Bonds. For January, the BLS set the inflation index at 281.148, an increase of 0.84% over the December number.

For TIPS. The January inflation report means that principal balances for all TIPS will increase 0.84% in March, following an increase of 0.31% in February. For the year ending in March, TIPS principal balances will have increased 7.5%. Here are the March inflation indexes for all TIPS.

For I Bonds. The January inflation report is the fourth in a six-month series that will determine the I Bond’s new inflation-adjusted variable rate, to be reset on May 1 based on non-seasonally adjusted inflation from September 2021 to March 2022. So far, with two months remaining, inflation has increased 2.49%, which would translate to an I Bond variable rate of 4.98%. Two months remain, and that rate is likely to climb higher. Here are the data so far:

What this means for future interest rates

Clearly, interest rates are heading higher. This inflation report continues a string of higher-than-consensus numbers, even though the consensus forecasts have been rising. Already this morning the 10-year Treasury note is trading with a yield of 1.98%, very close to breaking through the 2% barrier, a level we haven’t seen since July 2019. And stock market futures are falling, indicating the markets are again adjusting to a future with higher interest rates.

From this morning’s Wall Street Journal report:

High inflation is the dark side of the unusually strong economy, posing a challenge to the Federal Reserve as it tries to quell rising prices without damping growth.

“This is not encouraging news for the Fed in its battle to get inflation heading back towards the 2% target,” said James Knightley, chief international economist at ING. “Rate hikes will do nothing to resolve supply chain strains and worker shortages, but they can contribute to taking some of the steam out of the economy and allow demand and supply to start moving towards a better balance, at the expense of weaker growth.”

I’m sure the Federal Reserve has a very good idea where prices are heading, and the current trend of 40-year inflationary highs must be addressed. An easy prediction: Expect the Fed to begin raising short-term interest rates in March, and continue raising them through 2022.

What will happen to longer-term rates? That will depend on the economy and the stock market’s reaction to Fed actions. In the next few months, longer-term rates should climb higher, but possibly stabilize if the economy begins sinking or the stock market plummets.

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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 | 14 Comments