I Bonds

It looks like the inflation rate since May 2009 has been -2.78%. Does that actually cause the older bonds with higher fixed rates to actually drop to 0.00%?

If so, that is crazy, IMO.

I guess so:

The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate. The 0.00% earnings rate for I bonds bought from May through October 2009 will apply for their first six months after issue. The earnings rate combines a 0.10% fixed rate of return with the -5.56% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). When the inflation rate is less than zero, a bond's earnings rate is less than its fixed rate (but the earnings rate is never less than zero). The fixed rate applies for the 30-year life of I bonds purchased during this six-month period. The CPI-U decreased from 218.783 to 212.709 from September 2008 through March 2009, a six-month change of -2.78%.

Wow, my 2001 bonds went from over 8% to 0%!

Kudos for Treasury Direct! They sent me a prompt (and in-depth) response:

The reason for the 0.00% rate is that the inflation rate currently in effect is negative at such a point that it completely exceeds the fixed rate for your bond. Since I bonds are guaranteed to not lose value, the rate is set to 0% for this 6 month rate period.

At the risk of stating something you may already know, I bonds change rates every 6 months from the issue date of the bond. On those dates, the bonds take on new composite rates made up of the fixed rate you purchased the bond with and the inflation rate in effect at that time. Fixed rates are not minimum rates, but are the rate over and above inflation the bond will earn over its life. The inflation rate is the percentage change in the Consumer Price Index for all Urban customer (CPI-U) over the previous 6 month period. Inflation rates are set in May and November and apply for the period in between. For example, for a bond issued in October of a given year the inflation rate set in May applies to the bond the following October, and the rate set in November applies to your bond the following April. CPI-U data is released monthly by the Bureau of Labor Statistics (www.bls.gov (http://www.bls.gov/)).

What you're seeing with your bonds is that the inflation rate for I bonds set last May is negative for the first time in the 11 year history of the I bond program at -2.78%. When that is plugged into the I bond rate formula with your bond's fixed rate, the resulting composite rate is negative. Since I bonds are guaranteed to not lose value, the rate is set to 0%.

Your 9/2001 bond has a fixed rate of 3.00% and changes rates every September and March. The September rate is based on the previous May's rate announcement, and the March rate is based on the previous November's announcement. Last month, the bond entered the new rate period using the 3.00% fixed rate and the -2.78% inflation rate. When those two rates are plugged into the I bond rate formula, the resulting composite rate is -2.64%. Since I bonds can't lose value, the rate is then set to 0.00% from September 2009 through February 2010. It can change again in March 2010 based on the inflation rate that will be set next month (November 2009). If it helps, here is how the rate is calculated, then set to 0.00%:
Composite rate = [Fixed rate + 2 x Semiannual inflation rate + (Semiannual inflation rate X Fixed rate)]
CR = FR + 2x IR + IR x FR
CR = 0.03 + 2x -0.0278 + -0.0278 x 0.03
CR = 0.03 + -0.0556 + -0.000834
CR = 0.03 + -0.056434
CR = -0.0264
CR = -2.64%
CR = 0.00% (I bond rates can't be negative)

Since the rate is 0.00%, you won't see any change in value from September 2009 through March 2010. Assuming the November 2009 inflation rate is positive or negative at a rate that doesn't exceed the fixed rate, a positive rate would return to the bond in March 2010 with interest starting to accrue again starting April 1, 2010. If the inflation rate remains negative, you could see another 6 month period at 0%. Only the next few months will tell which way the inflation rate will go, but you can keep an eye on it at the Labor Statistics website at: http://www.bls.gov/cpi (http://www.bls.gov/cpi)

Using a 6 month inflation measure like I bonds do is always prone to much larger swings in rates than a longer-term would make (annual for example). If you look at your bonds from an annual perspective, you'll find the overall return is likely still competitive even though the current rate is 0%.

I hope this helps.
-Will
Savings Bond Calculator Support

http://www.treasurydirect.gov/BC/SBCPrice (http://www.treasurydirect.gov/BC/SBCPrice)

If you look at your bonds from an annual perspective, you'll find the overall return is likely still competitive even though the current rate is 0%.

There's a bit of optimistic spin! Competitive with those dynamite mutual fund MMs I guess. :rolleyes:

Well, funny thing is that your sort of right. The I-bonds are still maintaining, and perhaps even growing, the purchasing power of your dollar. After all, that is what they are supposed to do...beat inflation.

The problem with dumping I-bonds are the limits placed on annual purchases. Anyone holding them right now may be tempted to dump them. However, with the prospects of high inflation in the years to come, it may be a mistake. This is because if inflation takes off or goes hyper, you won't be able to re-enter the I-bond market with any meaningful holdings. Currently, you can only buy $5000 of I-bonds per SSN. Despite the 0% rate of interest, you are still "beating" inflation. If you dump them, you will lose your hedge.

Well, funny thing is that your sort of right. The I-bonds are still maintaining, and perhaps even growing, the purchasing power of your dollar. After all, that is what they are supposed to do...beat inflation.

The problem with dumping I-bonds are the limits placed on annual purchases. Anyone holding them right now may be tempted to dump them. However, with the prospects of high inflation in the years to come, it may be a mistake. This is because if inflation takes off or goes hyper, you won't be able to re-enter the I-bond market with any meaningful holdings. Currently, you can only buy $5000 of I-bonds per SSN. Despite the 0% rate of interest, you are still "beating" inflation. If you dump them, you will lose your hedge.
Oh, I won't sell mine any time soon. I have been averaging 7-8% recently (purchased 4/01 and 9/01).