I-Bond Rate Prediction for November 1st

I'm predicting a fixed rate of 0.0% and a composite rate of 0.74%.

In March 2010 the CPI-U was 217.631.
In September 2010 the CPI-U was 218.439.

That's a 0.37% increase over the six month period. Inflation has once again been very tame.

Fixed rate = 0.00%
Semiannual inflation rate = 0.37%

Composite rate = [Fixed rate + (2 x Semiannual inflation rate) + (Fixed rate x Semiannual inflation rate)]
Composite rate = [0.0000 + (2 x 0.0037) + (0.0000 x 0.0037)]
Composite rate = [0.0000 + 0.0074 + 0.0000000]
Composite rate = 0.0074
Composite rate = 0.74%

Here's why I think the fixed rate portion will be 0.0%.

Contrary to popular opinion within the stock market, I would argue that we are still in crisis mode and as such the government will set the I-Bond rate based on crisis conditions.



5-Year TIPS rates are currently -0.39% (uncharted territory). That would imply a negative I-Bond rate as seen in the chart above. The government won't do that though. I expect the rate to be stuck at the 0.0% floor.

Even at 0.0%, it would be clear that I-Bonds would be vastly superior to -0.39% 5-Year TIPS. I-Bonds can be cashed out without penalty after 5 years. Having the option to hold them an additional 25 years (tax deferred!) is clearly worth something too.



10-Year TIPS rates are currently 0.50%. That would imply an I-Bond rate well into negative territory. Once again, the government won't do that though. I therefore expect 0.0%.

Expect a lower rate on November's I bond

The fixed component in the earnings rate of the new I bond will likely be close to the spring rate, 0.2 percent. McBride expects 0.1 percent or 0.2 percent.

Greg McBride is a Bankrate senior financial analyst. I think his prediction will prove to be incorrect. I think 0.0 percent is the closest thing I've seen to a "sure thing" in a long, long time. I could be wrong though. Time will tell.

McBride also offers some options to I bonds in the current environment.

"Better inflation hedges are longer-term Treasury Inflation-Protected Securities such as the 10-year TIPS. And other asset classes such as dividend-paying stocks, REITs, commodities and other real assets, although there aren't any screaming values in that group," he says. The caveat is that other asset classes can be much more risky than the Treasury-backed I bond.

"Better" inflation hedges can be found but they can be "much more risky"? Seriously? Is the "better" adjusted for risk and reward or is the "better" just assuming maximum reward? Perhaps "much more risky" investments are always better? Who knows?

Take his 10-Year TIPS recommendation. It currently pays 0.5% over inflation but one cannot defer the taxes. That means you have to pay taxes on those inflationary gains each and every year. If inflation really picks up then I-Bonds paying just 0.2% would dramatically outperform 10-Year TIPS if held outside a retirement account. Further, if interest rates rise dramatically those 10-Year TIPS would experience a loss if sold to others. I-Bonds do not have that problem though. They can be cashed out after one year with a modest 3 month interest penalty or cashed out after just 5 years with no penalty at all.

Further, if deflation strikes again TIPS can lose money on any inflationary gains that accumulate. I-Bonds can never lose money, even if they have increased due to inflation in previous months. They can never drop in value.

On a risk vs. reward basis for those wishing serious inflation protection and deflation protection, I think today's 0.2% I-Bonds are vastly superior to 10-Year 0.5% TIPS.

Of course, you could try his commodity recommendation instead. Rumor has it that there is no wilder casino in the world than an online commodities account. Good luck!

This should not be considered investment advice.

Source Data:
St. Louis Fed: CPI-U
I Savings Bonds Rates & Terms
U.S. Treasury: Daily Treasury Real Yield Curve Rates