Yields Look Set to Drop for Treasury I Savings Bonds

The Treasury sets new I Bond rates every six months, and the last reset was in early November. The new rate will apply to newly purchased bonds and outstanding ones.

The new rate will be based on the change in the consumer price index from September 2022 through March 2023, multiplied by two, plus an as-yet-undetermined fixed rate, which now stands at 0.4%.

So far, there is inflation data for half the period—September through December. The CPI index is unchanged over those three months. Assuming monthly increases of 0.3% from January through March, and the new I bond rate would likely be around 2%. The Treasury uses non-seasonally adjusted CPI, which can differ slightly month to month from the more prominent seasonally adjusted figures.

Investors poured a record amount into I bonds in 2022, and there was frenzied buying that taxed the Treasury’s website prior to the semiannual rate reset in November as buyers were eager to lock in the 9.6% that prevailed from May through October 2022.

There were record monthly purchase transactions in October of $7 billion and $1 billion in just one day, Oct. 28, the final date to get the 9.6% rate.

The current I Bond rate of 6.89% was based on the CPI index from March through September 2022, which rose 3.24%. That change in the index is then multiplied by two. The current I bond rate is a composite of the CPI index and a fixed rate, which now stands at 0.4%.

I Bonds need to be bought through the TreasuryDirect website. Individuals are limited to $10,000 of annual purchases, but people with businesses structured as certain partnerships can get around that cap.

With the new rate in May likely to be much lower than the current rate, investors may want to buy I Bonds before the interest reset.

There is some uncertainty about the new fixed rate, which amounts to a real rate above inflation. It was set at 0.4% in November, up from zero in the prior six months. The fixed rate applies for the life of the bonds. The new fixed rate likely will be 1% or less based on yields on Treasury inflation-protected securities, or TIPS.

I Bonds need to be held for 12 months, and holders lose a quarter’s interest if they redeem the bonds within five years. They mature in 30 years but can be redeemed before then. Semiannual interest is added to the principal value of the bond and compounds over the life the bond. This differs from Treasury notes and bonds, which make cash interest payments. It’s a favorable feature because it eliminates interest-reinvestment risk.

One nice feature of I bonds is that holders can defer paying taxes on the interest income until they redeem the bonds. This gives I Bonds an IRA-like quality.

Interest is exempt from state and local income taxes, but is subject to federal income tax, which the same for Treasury notes and bonds. This makes I bond taxation more favorable than that of bank deposits whose interest is subject to federal, state, and local income taxes.

Write to Andrew Bary at andrew.bary@barrons.com