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New I Bond Fixed Rate Only 1%


This morning the Bureau of the Public Debt issued new earnings rate for the I Bond. As predicted last month, the inflation component is 5.70%. Unfortunately, the fixed rate was reduced from 1.2% to 1.0%. This gives a new composite rate of 6.73%.

The Savings Bond expert Dan Pederson (author of Savings Bonds: When to Hold, When to Fold and Everything In-Between) had predicted the fixed rate would fall since the inflation component rate was going up so much this time. His theory was that the Treasury Department would adjust the fixed rate to offset the inflation component. When other similar investments are only paying 5% or less, there's no need to offer I Bonds at rates over 7%. Looks like his theory was correct.

Another Savings Bond expert, Tom Adams (author of Savings Bond Alert), had predicted that the fixed rate would rise. His theory was that the I Bond fixed rate would be comparable to the 5-year yields on TIPS, the Treasury's marketable security that's comparable to the I Bonds. If that were true, the I Bond fixed rate should have gone up around 0.5%. As Adams states in his lastest blog post, the Treasury slapped small investors with lower rates today even though interest rates in the open market have risen during the last 6 months.

An I Bond rate of 6.73% may sound like a great rate, but this will change every 6 months based on inflation. If inflation goes down in the next 6 months, the next inflation component of the I Bond could fall to something like 2%. Then the composite rate of I Bonds purchased over the next 6 months would only yield around 3% after May of next year. For someone planning to hold I Bonds for the long term, the new 1% fixed rate is a big disappointment. If you assume inflation rates will average 3%, the long term rates of the I Bond will only be 4%.

Back in 2000, the fixed rate was as high as 3.6%. From 2000 to 2004, the I Bond fixed rates had declined to 1%. This trend finally ended last May when the fixed rate went up to 1.2%. Based just on market interest rates, it seemed this trend would continue. Looks like the Treasury had other considerations, perhaps thinking more of keeping the I Bond rates comparable to similar investments.

So the question will be if inflation returns to a more reasonable level over the next 6 months (let's say 3%) while short term interest rates continue to rise, will the Treasury make a big increase in the I Bond fixed rate next May? A 4% I Bond rate next May would likely be much lower than similar investments. Perhaps then they'll make a big increase in the fixed rate. So if you're looking at I Bonds for the long term it may be wise to wait to next May before purchasing them.

Refer to TreasuryDirect.gov for more information about I Bonds.