U.S. Inflation Rose 0.2% In February; I Bond Investors Get Bit Of Good News

by: Tipswatch

In a reversal of recent trends, food and energy prices increased while other prices were muted.

Core inflation rose only 0.1% in the month, below the consensus estimate of 0.2%.

Non-seasonally adjusted inflation rose 0.42% in February, a bit of good news for I Bonds' variable rate reset, coming May 1.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2% in February on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, "headline" inflation increased 1.5%.

The 12-month inflation number of 1.5% was the lowest recorded since September 2016.

February's 0.2% increase matched the consensus estimate and came after inflation was essentially unchanged from November to January. Some highlights from the report:

  • For the first time in many months, the gasoline index increased, with prices rising 1.5% in the month. This trend appears to be continuing in March, even though gas prices have fallen 9.1% over the last 12 months. (Gas prices fell a total of 15.7% from November to January.)
  • Food prices, which have been muted for years, jumped 0.4% in February and are now up 2.0% over the last 12 months. The index for fruits and vegetables rose 0.9% after declining in January.
  • Shelter prices rose 0.3% and are up 3.4% over 12 months.
  • Apparel prices also rose 0.3%, but remain down 0.8% over 12 months.
  • Prices for used cars and trucks dipped 0.7%.

Today's report ran counter to recent inflation trends, with food and energy prices rising and some other costs declining. That meant that core inflation - which omits food and energy - increased only 0.1% in February, below the consensus estimate of 0.2% and the smallest increase since August 2018. Core prices are now up 2.1% over the last 12 months, meeting the definition of "moderate inflation."

Here's the 12-month trend for all-items headline inflation versus core inflation, showing the sharp decline in overall inflation (primarily influenced by falling energy prices) versus the relative stability of core inflation:

One-year inflation trend (Source: Bureau of Labor Statistics)

What this means for TIPS and I Bonds

Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates on I Bonds. The BLS set the February inflation index at 252.776, an increase of 0.42% over the January number.

For TIPS: The February inflation report means that principal balances for all TIPS will be adjusted 0.42% higher in April. This will be the highest monthly increase since July 2018, which also had an increase of 0.42% based on the May 2018 inflation report. Here are the new April Inflation Indexes for all TIPS.

For I Bonds: February's non-seasonally adjusted increase of 0.42% is good news for holders of - and possible future investors in - I Bonds. The February report is the fifth in a series of six monthly numbers that will determine the I Bond's new inflation-adjusted variable rate, which will be reset May 1.

At this point, with five of six months in the books, the inflation rate is running at 0.13%, finally rising above a negative number. That would translate to a variable rate of 0.26% for six months, well below the current variable rate of 2.32%. But, at least the number has turned positive, which is good news because a negative number would also eat away at an I Bond's fixed rate.

The final report in this six-month sequence will be coming April 10, 2019, at 8:30 a.m. EDT. At that point, the variable rate will be set, and I Bond investors will have three weeks to decide whether to buy before May 1, or after. Buying before will lock in the current fixed rate of 0.5% for the life of the I Bond, and the current variable rate of 2.32% for six months.

I'll be analyzing that decision after the March inflation report is revealed, but I'll give you a hint: I'll probably be buying before May 1 - because I believe the fixed rate of 0.5% stands a good chance of dropping in the May 1 reset.

Here are the numbers so far:

I Bonds and Inflation (Source: TipsWatch.com)

What this means for future interest rates

Today's report reminds us: Inflation is not dead. If gasoline prices continue creeping higher, along with food and shelter costs, we could see a reasonably strong resurgence in inflation. This assumes, of course, that the economy doesn't crater.

I believe the Federal Reserve is comfortable seeing inflation rates rising above 2.0% and will be cautious about raising short-term rates higher in 2019. Could we see a single 25-basis-point increase in 2019? Possibly. But not likely.

From this morning's Wall Street Journal report:

The mix of muted price pressures and steady wage gains appears to leave consumers in good shape. Still, the latest inflation reading is likely to further bolster Fed officials' decision to stop raising interest rates.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.