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Inflation News: October I Bonds Compare Favorably to Top 1-Year CDs


Inflation News: October I Bonds Compare Favorably to Top 1-Year CDs

The Labor Department released the September Consumer Price Index (CPI) numbers today, and with these numbers, the next Series I Savings Bond inflation component can be computed. This allows us to calculate the earnings for I Bonds purchased this month and redeemed from October 2017 to January 2018. Sometimes I Bonds compare favorably to 1-year CDs, and that is the case this time. Inflation in the last six months has gone up. Today’s report showed that the CPI-U increased by 1.38% in the last six months (an annualized rate of 2.76%.) The 2.76% rate should be the I Bond inflation component that will be announced at the start of November. That helps offset the current inflation rate of 0.16% if an I Bond is purchased in October, and it makes an I Bond a pretty good deal as compared to current 12-month CDs. I’ll explain the details below.

Before I review the details of my I Bond rate calculations, today’s inflation report is also important for other reasons. Today’s inflation report is used by the Social Security Administration to determine the cost of living adjustment in 2017. Also, inflation is a major factor in the Fed’s decision on rates.

Social Security Benefits Will Rise 0.3% in 2017

As seen in the CPI-U over the last six months, inflation went up quite a bit. However, the inflation was low for the previous six months. The net result is a slight increase of the Social Security cost-of-living adjustment (COLA) for 2017. According to ssa.gov, “The latest COLA is 0.3 percent for Social Security benefits and SSI payments.”

Impact on the Fed’s Rate Decision

The Fed primarily focuses on core CPI which excludes volatile food and energy prices. Core CPI increased 0.1% in September after climbing 0.3% in August. That slowed the year-on-year increase in the core CPI to 2.2% following a 2.3% rise in August. The consensus forecast for the core CPI was 0.2%. So the September core CPI was slightly below the forecast. That may give the Fed a little more justification to delay the next rate hike.

November I Bond Inflation Rate Should be 2.76%

I’ve done the calculations based on these latest CPI numbers, and the I Bond inflation component taking effect in November should be 2.76%. That’s the highest I Bond inflation rate since 2011, and it’s much higher than the current rate of 0.16%. The I Bond inflation component is added on to the I Bond fixed rate to derive the I Bond composite rate. The fixed rate is currently 0.10%, and it probably won’t change much if at all in November. We won’t know the November fixed rate until Tuesday November 1st.

If you buy I Bonds before the end of October, you can know the rate of return you'll receive if you redeem the I Bonds between October 2017 and January 2018. The interest rate for the first 6 months will be based on the current inflation component (0.16%). The next 6 months will be based on this new rate (2.76%). After that, it'll depend on future inflation numbers. The current fixed rate component of 0.10% will stay the same for the life of the bond. Below are the details of calculating the expected rate of return.

I Bond Rates of Return for October 2016 Purchase

From Treasury Direct I Savings Bonds FAQs:

the inflation rate announced in November is the change between the CPI-U figures from the preceding March and September.

All previous CPI-U numbers are available from this government webpage. The CPI-U for March 2016 was 238.132. Based on today’s release, September 2016 CPI-U was 241.428. This is an increase of 1.38%. The annualized version of this is 2.76%.

If you buy before November, you'll receive the current I-Bond fixed rate of 0.10% for the life of the I Bond. The inflation component will be added to this rate and will change every 6 months. The current inflation component is 0.16%, and the composite rate is 0.26%. Here's an estimate of the return for the next year:

  • 0.26% from October 2016 through March 2017
  • 2.86% from April 2017 through September 2017

I Bonds increase in value on the first day of the month. So on November 1st, you'll earn the interest for the full month of October. So for maximum return, it's best to buy I Bonds near the end of the month and redeem them early in the month.

If you redeem an I Bond before 5 years, you lose the last 3 months of interest. So based on this and the above numbers, if you buy an I Bond on October 28, 2016, the value of the I Bond on October 1, 2017 would be about 0.85% higher. For 11 months, this comes out to an annualized yield of about 0.92%.

Below is an estimated annualized return for I Bond redemptions from October 1, 2017 to January 1, 2018. It is assumed you will buy the I Bond at the end of October 2016 which gives you almost an extra month of interest. This effectively reduces the 3-month penalty to 2 months.

  • 0.92% (11mo) redeem on 10/1/17, 6mo of 0.26%, 3mo of 2.86%, and 3mo of 0% (penalty)
  • 1.08% (12mo) redeem on 11/1/17, 6mo of 0.26%, 4mo of 2.86%, and 3mo of 0% (penalty)
  • 1.22% (13mo) redeem on 12/1/17, 6mo of 0.26%, 5mo of 2.86%, and 3mo of 0% (penalty)
  • 1.34% (14mo) redeem on 01/1/18, 6mo of 0.26%, 6mo of 2.86%, and 3mo of 0% (penalty)

The highest guaranteed rate would be an annualized return of 1.34% for about 14 months. Note, it's best not to wait until the last day of the month to buy I Bonds at Treasury Direct. In 2011 I described my experiment in seeing how late in the month I could buy an I Bond. I found you should make sure the purchase is no later than the second to last business day of the month.

Compared to CD Rates

As you can see, the above rates for 13 and 14 months are close to the top 1-year CD rates that you can get from internet banks. If you have to worry about state income tax, the I Bond may return more for you than the best 1-year CDs since I Bonds are exempt from state income tax.

To search for the best nationwide CD rates and the best CD rates in your state, please refer to our CD rates table.

Unfortunately, an exact comparison between I Bonds and long-term CDs is not possible. The reason is that the I Bond inflation rate changes every six months. For this short period of time from now to before November, we know the I Bond inflation rate for 12 months. We can only guess about the I Bond inflation rate after that. The best we can do is to make an estimate of the future inflation rates.

One way to estimate future inflation rates is to use the historical average. In 2014 I calculated the average I Bond inflation rate since the I Bond program began in September 1998. That average was 2.57%. This takes into account the period in 2009 when the I Bond inflation rate was negative. Since the composite rate can never be negative, I used zero for this period in calculating the average.

If the I Bond inflation rate average 2.57% over the next 5 years, an I Bond purchased today will compare favorably to 5-year CDs purchased today. The best 5-year CD rate that’s nationally available is currently 2.30% APY at Mountain America Credit Union.

If you have older I Bonds, you probably have I Bond fixed rates much higher than 0.10%, and if you're fortunate enough to have purchased I Bonds before 2001, you probably have fixed rates over 3.00%. So those I Bonds are especially good deals in today's environment.

Remember the $10,000 Annual Purchase Limit

Don’t forget that the annual purchase limit is $10,000 (excluding the purchases using your tax refund). Also, remember that the Treasury ended offering paper savings bonds at banks. However, it did double the annual purchase limit at Treasury Direct (see post).

I Bond Features

Below is a summary of the I Bond features. More information is available at this Treasury I Bond page:

  • Can't be redeemed within 12 months of issue date
  • Lose 3 months interest if redeemed within 5 years
  • Interest is composed of fixed and inflation-based rate
  • Fixed rate remains for life of bond
  • Inflation-based rate changes every 6 months after issue date
  • New rates announced every six months on November and May 1st
  • Federal tax can be deferred on interest until bond is redeemed
  • Interest is exempt from state and local tax
  • Some or all interest is tax exempt when used for educational expenses
  • $10,000 maximum of I Bond purchases per year (excluding purchases using your tax refund) - total was $60,000 before 2008 (Treasury's press release).

For more details about the purchase limit, please refer to the Treasury Direct's FAQ on the new purchase limit.

Anonymous   |     |   Comment #1
Great news.  Given 50% of my retirement fund is in 1% money market at Ally, I have an equal amount in I Bonds which I purchased from 1998 thru 2002 getting a fixed rate of 3.5% before inflation.  This means between money market and I Bonds I will average above 3%.

When I was purchasing the I Bonds, everyone told me I was "nuts".  Now I thank God for that move.
Anonymous   |     |   Comment #3
Good deal for you #1..... I have a bunch at 1.60% base and 3% base... I'll be averaging 5% but its only for 6 months unfortunately.
Anonymous   |     |   Comment #14
Good for you that you think that way, I think the other way around. If my money are now in the treasuries, that means I'm now part of the pool of the national debt too.
Should anything happen politically or economically and the US can no longer service the national debt, my money are part of that problem and may not see them at all in the future, because I decided to bail out the present  people who exit the treasuries.
There is only one cash register in the US government it is the treasury and everything is paid out of one place and the investors will be last on the priority list to get paid in case of crisis.
DaveJ   |     |   Comment #20
Anonymous comment #1.You might consider Andrews Credit Union for part of that Ally money. 3% for 7 years. I also have some 3% fixed rate Ibonds that I'm grateful to have.I transferred an IRA to Andrews a couple months ago. I'm assuming your retirement fund is an IRA and not after tax money. That rate is only IRA's. I also have some after tax dollars in Ally 1% savings.
Anonymous   |     |   Comment #23
Thanks Dave, I will check it out. It is IRA money I have in Ally. Regards, Bob
Anonymous   |     |   Comment #24
What's the etp for 7year cd?
scottj   |     |   Comment #2
Been trying to understand this stuff for the last 5 years and it still confuses me. Does this mean that 2.76% will be added to all my ibonds? I have not purchased any yet for this year as I was waiting to see rate for November. Is it worth waiting till next month  to see if fixed amount goes up? Also  I have no intention of redeeming my ibond purchases early.
Anonymous   |     |   Comment #4
2.76% plus your base rate
Anonymous   |     |   Comment #5
Finally some better news
Anonymous   |     |   Comment #13
The main reason is this:
Most foreign governments are lighting up on US treasuries because they can see that the national debt soon will not be manageable and new money must come in, therefore to lure someone to invest in the treasuries the I-bonds, notes and bills are used as vehicle to lure the people with money to pay those that are exiting, I wonder who will bail the present entries in the I-bonds and e-notes.

I will stay away because if there are not buyers in future, the government may forbid withdrawals of your own money.
Arthur McBride
Arthur McBride (anonymous)   |     |   Comment #6
Wait to Nov 1st to buy. It would be foolish to buy in October and suffer 0.26 interest for 6 months.
Anonymous   |     |   Comment #19
If you but the bond in late October, you would only "suffer" for 5 months and a few days.
jimbeau   |     |   Comment #7
The six month average used to calculate the iBonds variable interest rate have been languishing below 1% for as long as I've had them.  That's about the last five years.  During that period of time the annualized rate has been below 2%. So, this is a first for me. The last 6 month rate was 0.16%.   With that paltry rate, I didn't think that I'd even been considering buying more this year.  With the new rate of 2.76%, I may as well pop for the 20K that's available to married couples each year instead of purchasing more CDs.
I tend to compare iBonds more to 5 year TIPS and CD's.  Right now 5 year TIPS have a negative yield.  So, that mean's your going to pay above par for the bond.   Since the government only guarantees that you'll get back par when it matures, that means you can lose money on the bond if a protracted deflationary period occurs.    During the deflationary period last year, the "book value" of some TIPS I own actually lost principal for a short period of time.  iBonds can't lose principal.

If iBonds can match the best 5 year CD rate, they're definitely the better way to go to preserve both principal and purchasing power.  iBonds actually have a better EWP than CD's.   So now, their looking more attractive than they've been in a while.  
Anonymous   |     |   Comment #8
I don't understand why not to wait next month?

An average yield for holding 12 months would be:
6 months 2.86% + 3 months 0.1% (worst case, probably better) + 3 months 0% (penalty) = average ~1.455%.
Anonymous   |     |   Comment #10
You're math assumes the 0.1% base doesn't also change, but lately it gets set to 0% whenever the inflation component is a non-trivial amount.
Anonymous   |     |   Comment #15
Fair enough, but that does not change the results much: getting the base rate as 0% will give a 0.075% lower yield (-0.1% for 9M, 0% for 3M), so average @12M is at least 1.38%.

((( OFF: Is there a script here that steals focus from the editbox?! It's freaking annoying..)))
Anonymous   |     |   Comment #11
Agreed as to waiting...but I "figure" 6 months of the new rate and (worst case) 0% for six months then (including 3 months penalty) with a return of about 1.43%....what did I do wrong?
Cat Chance
Cat Chance   |     |   Comment #9
Re: next year COLA rate of .3%

Ken, so I did the math myself of figuring out next year's COLA by using their average formula and I come out with a figure of .0035106 which according to their rules should be rounded up to .4% right? Or at least this is what I read on various websites on how the COLA formula is done.

Can you do the math also and tell me where I ****ed up? Or quite possibly they might have been the ones to **** it up... could be possible right? LOL Anyway, seriously though, I did the math and the final COLA number should be rounded up to .4%. What do you think after doing the math too?
Cat Chance
Cat Chance   |     |   Comment #18
So never mind, it was figured out on the Veterans Benefit Forum (VBN). The Bureau of Labor Statistics revised the Jul & Aug CPI-W numbers downward at the last second (the same day the Sep number was released) so this affected the formula obviously. They were lowered just enough to make the final number just below the round up so it was rounded down. Pretty fishy though that they revised the Jul & Aug numbers at the last minute like that but it is what it is... .3
Anonymous   |     |   Comment #16
Okay deal for anyone looking for a 1 year investment, but 1.38% 1 year anticipated worst possible case rate is not much too jump up and down about.  I liked the I-bonds when they had the higher fixed rates but when they neared 0, that has also often been the case on the total low rate you get when the negative change in inflation is factored in.  So I have had enough of that going on with the 0 or near 0 fixed rate bonds that I will be or have sold most of them and just kept the ones with the higher fixed rates. 
Anonymous   |     |   Comment #17
I like your logic...with fewer buyers, rates will (continue to) rise
Anonymous   |     |   Comment #21
#17, I believe you understand that if the rates continue to rise without the economy covering that rise, the taxes must go up or the benefits must come down or a combination of both. Therefore the COLA is just a joke and the Obamacare premium and taxes are going up and welfare benefits are coming down too.
Anonymous   |     |   Comment #22
Works for me...higher rates will drive banks back to looking at the spread for their profit BY developing new borrowers rather than the current model of the bank of relying on fee.  Banks want higher rates too!