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Next Series I Bond Rates May Be Under 1%


The Bureau of Labor Statistics announced yesterday that the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in February, before seasonal adjustment. The February CPI-U level was 198.7.

The core CPI, which excludes food and energy, rose only 0.1% which was less than the 0.2% rise predicted by economists and the 0.2% rise seen in January. This doesn't change the expectations for another 0.25% increase in the funds rate at the next Fed meeting on March 28. However, it adds uncertainty of another rate hike in May (more, CNN).

For US Series I Bonds, there's one more month of CPI-U data that will be used for the inflation component of the I Bond rates starting this May. The important thing to note is that February's CPI-U level of 198.7 is still under September 2005's level of 198.8. If the March index is still under 198.8, the next I Bond inflation compoent will be negative. Those who bought I Bonds since November 2005 could have 6 months with a rate of under 1%.

Why would the rate be under 1%?

I Bond rates are composed of the inflation component and a fixed rate componenet. The inflation component changes every 6 months based on the rates set every May and November. The fixed rate remains the same through the life of the Bond. I Bonds bought since November have a fixed rate of 1% so if the new May inflation component is negative, an I Bond bought last November may earn less than 1% for 6 months after May 1st.

Predictions? Recommendations?

Based on gas prices, it seems likely that March inflation will likely be higher than February's inflation. Let's assume March's inflation matches that of January's with a gain of 0.7%. That would prevent a negative I Bond inflation component in May. However, the component would still be very low at about 1.3%. I Bonds purchased last November would earn about 2.3% starting in May. Currently, I Bonds purchased in November are earning 6.73%. This will surely disappoint many who purchased I Bonds to take advantage of the very high 6.73% rate.

For those interested in I Bonds, there is one good thing if the next inflation component is low. It may help push the I Bond fixed rates higher. If May's inflation component is only 1.3% and the fixed rate component remains at only 1%, the composite rate would only be about 2.3%. Since this is about half of the rate of the best savings accounts that are now available, I Bonds would look very unattractive. So this should increase the odds that the Treasurey will do a major bump to the fixed rate component. I'm predicting it may go to at least 2%.

From the time that the I Bonds started in September 1998, the highest fixed rate has been 3.60% in May 2000. The lowest it has been is 1% which is the current rate. Last November, it was lowered from 1.2% to 1.0%. It seems the Treasury was compensating for the very high November inflation component of 5.70%. Hopefully, the Treasury will compensate in the opposite way this time. I'm predicting a 1% increase to the fixed rate. At the very least, it should increase to some extent. So for those considering I Bonds as a long term investment, I would recommend waiting until May. For those who plan on holding the I Bond for more than 5 years, only the fixed rate is of concern.

Below is the full list of I Bond fixed and inflation component rates based on this Treasury data. The composite rate is slightly more than the sum of the fixed rate and inflation rate. Refer to that Treasury page for the exact equation. Also, I've included the targeted federal funds rate for reference. The funds rate is the rate that was current on either May 1st or November 1st. This is based on data from here.

Date Fixed Infl Targeted
Rate Cmp Fed Funds
Nov 2005 1.00% 5.70% 4.00%
May 2005 1.20% 3.58% 2.75%
Nov 2004 1.00% 2.66% 1.75%
May 2004 1.00% 2.38% 1.00%
Nov 2003 1.10% 1.08% 1.00%
May 2003 1.10% 3.54% 1.25%
Nov 2002 1.60% 2.46% 1.75%
May 2002 2.00% 0.56% 1.75%
Nov 2001 2.00% 2.38% 2.50%
May 2001 3.00% 2.88% 4.50%
Nov 2000 3.40% 3.04% 6.50%
May 2000 3.60% 3.82% 6.00%
Nov 1999 3.40% 3.52% 5.25%
May 1999 3.30% 1.72% 4.75%
Nov 1998 3.30% 1.72% 5.00%
Sep 1998 3.40% 1.24% 5.50%

For more information on I Bonds, refer to this previous post.
trip   |     |   Comment #1
Curses. I bought one of the 6.73% bonds in Nov. I should have studied up a little more. So if the rate comes in at 1.0%, would that create an annual rate of 3.865%? I could have done bettter than that.
Banking Guy
Banking Guy   |     |   Comment #2
I think there's a good chance that the inflation component will be at least 1%. Your fixed rate will remain the same at 1%. So in May, your new total return would be 2% for the next 6 months. The annual rate would be the average of 6.73% and 2% (4.365%). That's just a little below the 1-year CD rates that were being offered in November.
Anonymous   |     |   Comment #3
I bonds can be redeemed after one year, the penalty is 3months interest. I think the penalty is based on the current rate at that time. If it is below 4% rate(which I think will happen) I will take my 3 month hit and move to CD's.
Banking Guy
Banking Guy   |     |   Comment #4
The March CPI-U was announced on April 19, 2006. Refer to this post for the details about I Bond rates starting May 1st, 2006.