U.S. Series I Savings Bonds purchased from May through October 2019 will earn a fixed rate of 0.50%, holding at the highest rate in 10 years despite a substantial decline in real yields in recent months.
Combined with the new inflation-adjusted variable rate - based on U.S. inflation from September 2018 to March 2019 - these new I Bonds will earn a composite rate of 1.90% for six months, the Treasury announced today. This is a drop from the composite rate of 2.83% for I Bonds purchased from November 2018 to April 2019.
The fixed rate is, in essence, the I Bond's "real return," the interest earned above inflation. The current rate of 0.50% will continue at the highest level since November 2008, when the Treasury set it at 0.70%.
The decision to hold the fixed rate at 0.50% is a surprise; I'd actually call it a "shocker." An I Bond's fixed rate is extremely important because it stays with the savings bond until it is redeemed, or matures in 30 years. Six months ago, when the Treasury first raised the fixed rate to 0.50%, a 5-year TIPS was yielding 1.08% and a 10-year, 1.10%. Yesterday, those comparable yields were 0.43% for the 5-year (down 65 basis points) and 0.56% for the 10-year, down 64 basis points).
So today's decision sets the I Bond's fixed rate higher than the real yield on a comparable 5-year TIPS. Because an I Bond can be redeemed without any penalty after 5 years, it is exactly comparable to a 5-year TIPS. But it has many advantages: deferred taxes on interest, a flexible maturity, better compounding of interest and much better deflation protection.
The Treasury just made the I Bond the best intermediate-term inflation protection product on the market. This one chart says it all, showing just how dramatically the spread of the 5-year TIPS real yield has narrowed versus an I Bond's fixed rate since November 2018:
And here is a historical look at the 5-year and 10-year spreads comparing the I Bond's fixed rate versus 5- and 10-year TIPS real yields. Just focus on the 10-year yield spread, which with today's decision is 6 basis points. In May 2017, when the spread was 37 basis points, the Treasury set the fixed rate at 0.0%. Even in November 2013, when the spread was 20 basis points, the Treasury set the fixed rate at 0.20%.
It's a gift. Be thankful.
Today's move by the Treasury was a stunner, and reinforces my past complaints that "I don't know what the hell they'll do." However, in this case, setting the fixed rate at 0.50% was a gift to small-scale investors, and I am going to applaud the decision, even though it made my predictions of a fixed rate of 0.20% to 0.30% look dumb. I had 95% confidence the fixed rate would fall. I was wrong. But it was a nice way to be wrong.
My advice last month was to buy your full allocation of I Bonds - $10,000 per person per year - before May 1. That ends up still being a good move, because it will capture the higher composite rate of 2.83% for a full six months, and then six months at 1.90%. That's a combined annual rate of 2.36% for a year, a decent return for an inflation-protected investment.
But if you didn't follow my advice (remember, I'm a journalist, not a financial adviser) then you can feel free to buy I Bonds anytime through October and feel great about it. You can even say, "Dave's an idiot." The next rate reset will come November 1.
How the composite rate is determined
The composite rate for I Bonds purchased from May to October combines the current fixed rate of 0.50% with the new inflation-adjusted variable rate of 1.40%. That variable rate was set in stone on April 10 with the release of the March inflation report. Here are the numbers, based on non-seasonally-adjusted inflation:
Because the composite rate reflects an annualized number, the Treasury doesn't just add the 0.50% and the 1.40% to get 1.90%, although that addition works this time. For finance nerds, here is the actual calculation the Treasury uses:
An update on EE Bonds
The Treasury continued the permanent fixed rate on EE Bonds at 0.1%, which obviously is horrible. However, it also continued terms stating that an EE Bond will double in value if held for 20 years, which creates a tax-deferred interest rate of about 3.5%, much higher than the yield of a 20-year Treasury, currently 2.75%. Here is the Treasury's wording:
Series EE bonds issued from November 2018 through April 2019 earn today’s announced rate of 0.10%. All Series EE bonds issued since May 2005 earn a fixed rate in the first 20 years after issue. At 20 years, the bonds will be worth at least two times their purchase price. The bonds will continue to earn interest at their original fixed rate for an additional 10 years unless new terms and conditions are announced before the final 10-year period begins.
What this means: If you invest in EE Bonds, you need to be absolutely sure you can hold them 20 years. If you hold them 19 years, 11 months, you will earn 0.1%. At 20 years, your investment doubles in value. Then, redeem the EE Bonds immediately.
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.
Additional disclosure: David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. The investments he recommends can be purchased through the Treasury or other providers without fees, commissions or carrying charges.