The silver lining of soaring inflation: I bond yields set to climb above 9%

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CHAPEL HILL, NC — Want to earn more than 8% with US Treasuries over the next 12 months?

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

Yet even this modest goal seems incredibly out of reach. The one-year Treasury yield currently stands at just 1.9%.

One solution is I-Bonds, which are US savings bonds whose yields are adjusted for the prevailing rate of inflation. More specifically, their return is adjusted twice a year, in May and November, according to the six-month change in the consumer price index. Its current yield, set last November, was 7.1% (double the change in the CPI from April to September of last year).

Based on this week’s inflation report, that yield should be pegged at 9.6% on May 1 (twice the CPI change from October to March). The Treasury Department is expected to announce the new rate in the coming weeks.

I’ve written about I-Bonds before, and I’ll refer you to this column for several important details. You can’t buy an unlimited amount of these I-Bonds, for example, and you can’t buy them in an IRA. But you are allowed to buy $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 results in a large allocation of fixed income securities, large enough to satisfy the asset allocation requirements of all but those with very large net worth .

Zvi Bodie has done as much as anyone, if not more, to defend the I-Bonds. Bodie, now retired, spent four decades as a professor of finance at Boston University. In an interview, he said buying I-Bonds was a no-brainer, and he implores all of us to buy as many as we can each year.

Buy now or in May?

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

It’s not that bad, of course. Could you do better in the next 12 months by waiting until May to buy? The answer depends on what the 6-month inflation rate will be this fall when the Treasury sets the new I-Bond interest rate. If it’s below 7.1%, you better buy an I-Bond this month. If it is higher, you have to wait until May.

Your guess is as good as mine which of these two scenarios will play out. Markets are celebrating indications this week that inflation may have peaked with this latest report and is poised to come down significantly. The S&P 500, for example, rose more than 1% in the immediate trading following the release of this report.

Bodie suggests that if you don’t want to bet on what inflation will be like this fall, you simply split your I-Bond purchase in half, buying 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 of this year to April 30 next year. It’s far better than any alternative savings vehicle that guarantees repayment of capital.

In any case, Harry Sit, author of The finance junkie blog, reminds us that it is not necessary to focus only on the next 12 months. In an email, he pointed out that “I-Bonds are good for 30 years.” Unlike TIPS, moreover, I-Bonds are structured in such a way that their return can never be negative.

Sit recommends buying I-Bonds this month rather than waiting until May. He points out that you earn a whole month’s interest even when you buy towards the end of the month. So that 8%+ return I mentioned at the beginning can really be considered even better, since it’s a holding period of less than a year, as short as 11 months and a day.

Sit cautions, however, that since April 30 of this year is a Saturday, you shouldn’t try to cut it too close. “The last day to issue the [I-Bond] for April it is April 29th. The order must be placed by April 28 at the latest. I would give a few more days of buffer in case something went wrong. If you don’t have an account set up yet, sometimes they [the U.S. Treasury] require additional identity verification, which takes time to resolve. If you already have an account ready to go, you can pre-schedule the purchase now for the 27th. If that somehow fails, you still have another chance on the 28th.”

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

Now read: Hedging against inflation: TIPS vs I Bonds

After: Peak inflation? The worst may be over, but Americans will likely continue to pay a heavy price

More: Read MarketWatch’s “How to Invest” series


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