The golden edge of budding inflation: I-bond yields should rise above 9%

CHAPEL HILL, NC – Do you want to secure a return of more than 8% on US Treasurys over the next 12 months?

Of course you would, especially given the higher-than-expected inflation figures reported this week, with the consumer price index rising 8.5% over the last 12 months. Our absolute minimum goal with a US Treasury Department is not to lose to inflation.

Yet even this modest goal seems impossible out of reach. The one-year government interest rate is currently only 1.9%.

One solution is I-Bonds, which are US savings bonds whose returns are adjusted for current inflation. Specifically, their returns are adjusted twice a year – in May and November – according to the consumer price index’s subsequent 6-month change. Its current return, set in November last year, was 7.1% (twice the CPI change from April to September last year).

Based on this week’s inflation report, this interest rate should be set at 9.6% on 1 May (twice the CPI change from October to March). The Ministry of Finance should announce the new course in the next few weeks.

I have written about I-Bonds before and I refer you to that column for more important details. For example, you cannot buy an unlimited amount of these I-Bonds, and you cannot buy them in an IRA. However, you are allowed to purchase $ 10,000 of such bonds each year ($ 20,000 per married couple) and an additional $ 5,000 per year with your tax refund. A strategy of buying the maximum amount each year over a long period of time results in a significant fixed income allocation – large enough to satisfy the asset allocation requirements for all but those with a very large net worth.

Zvi Bodie has done as much as anyone, if not more, to win I-Bonds. Bodie, now retired, was a finance professor at Boston University for four decades. In an interview, he said that buying I-Bonds is an easy task, and he asks us all to buy as much as we can, every single year.

Buy now or in May?

The only real question is whether to buy an I-Bond now or wait until May. This is difficult because your I-Bond’s inflation adjustment factor is reset every six months based on the first month of your purchase. So if you buy an I-Bond now, the interest rate you will earn over the next six months will be the interest rate set by the US Treasury Department last November – 7.1%. And over the six-month period beginning in October, your interest rate will be equal to the rate that the US Treasury Department will set in May – which I expect will be 9.6%. This is an average of 8.4 per cent.

Of course, that’s not half bad. Could you do better over the next 12 months by waiting until May to buy? The answer depends on what the subsequent 6-month inflation rate will be in the autumn, when the Treasury establishes the new I-Bond interest rate. If it is lower than 7.1%, you would be better off buying an I-Bond this month. If it is higher, wait until May.

Your guess is as good as mine, which of these two scenarios will unfold. Markets this week are celebrating indications that inflation may have peaked with this latest report and are declining markedly. For example, the S&P 500 increased by more than 1% in immediate trade following the publication of this report.

Bodie suggests that if you do not want to bet on how inflation will be this fall, simply split your I-Bond purchase in two, buy half now and half in May.

However, it’s hard to go wrong even if you make the “wrong” choice. Even if you wait until May to buy an I-Bond and the November reset rate is as low as 4%, you will still earn 6.8% over the 12 months from April 30 this year to April 30 next year. It is far better than any alternative savings that guarantees repayment of the principal.

In any case, Harry Sit, author of The Finance Buff blog, reminds us that there is no need to focus on just the next 12 months. In an email, he pointed out that “I-Bonds are good for 30 years.” In contrast to TIPS, I-bonds are also structured so that their returns can never be negative.

Its recommended that we buy I-Bonds this month rather than wait until May. He points out that you earn a whole month’s interest even when you buy near the end of the month. So the yield of more than 8%, which I mentioned at the beginning, can really be perceived as even better, as it is for a holding period shorter than a year – as short as 11 months and a day.

Its a warning, though, that since April 30 this year is a Saturday, you should not try to cut it too close. “The last day to issue [I-Bond] for April is April 29th. The order must be submitted no later than April 28. I would give a few days more buffer if something should go wrong. If you have not already created an account, they can sometimes [the U.S. Treasury] requires additional ID verification, which takes time to resolve. If you already have an account that is good to go, you can pre-order the purchase now for the 27th. If it fails somehow, you still have a chance for the 28th.

Mark Hulbert is a regular contributor to MarketWatch. Hans Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at mark@hulbertratings.com.

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