So as of yesterday I ran the numbers on what the big fixed income players were pricing expected inflation in the future. Here you can see the graphs. All rates are annual / annualized rates.
First I looked up the treasury and TIPS yields for the various maturities from 0-5 years, linearly interpolating if there wasn’t an exact bond with the right maturity. Then I subtracted these, ie Treasury - TIPS for the same maturity, to get the breakeven (market expected) inflation.
Then I bootstrapped the breakeven inflation rate for the first 6 months, together with the breakeven inflation for the whole first year, to find out how much inflation was happening the 2nd 6 months, etc (carefully for compounding). This is the forward curve for inflation expectations. The red line is the breakeven inflation curve from the last graph, and the blue line is how much the annual inflation rate is for each 6 month period ending on the time given. So the first 6 months is expected to be 8%, then the 2nd 6 months is expected to be 2.5%, etc. Normally you’d smooth this, but good enough for government work.
Then I used these expected inflation amounts for each of the successive 6 month increments to find out what an I bond would pay if it was held for different maturities. You always hold for the first year (for the great 7.1% / 9.7% rates), and then you possibly hold for some number of additional 6 month periods, and then (when the rate is no good anymore) you hold for 3 more months and forfeit that unless you made it to 5 years.
I used 2 models for the inflation.
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Pink Line. One was a flat 3.4% annual rate over the whole 4 year period, corresponding to roughly the breakeven 4 year inflation (since we get the first year known, and want to know the next 4 years to make it, potentially, to the 5 year penalty maturity).
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Blue Line. The other was the inflation forward curve rates, which were higher initially and lower later, and probably more in line with what is reasonable. The blue line uses the expected inflation over time, while the pink line uses the flat / average inflation rate throughout.
The other lines are to compare the I bonds held for varying times with other fixed income options of that maturity (and those are are all much much worse currently; CD rates from bankrate’s top national option).
Here’s the same info in table form:
years |
term |
maturity |
I bond (market) |
I bond (flat) |
best CD |
treasury |
TIPS |
1 |
4/1/23 |
7/1/23 |
7.31% |
7.31% |
1.30% |
1.84% |
-3.25% |
1.5 |
10/1/23 |
1/1/24 |
7.51% |
6.15% |
1.40% |
2.15% |
-2.60% |
2 |
4/1/24 |
7/1/24 |
6.36% |
5.55% |
1.65% |
2.46% |
-1.73% |
2.5 |
10/1/24 |
1/1/25 |
5.94% |
5.16% |
na |
2.57% |
-1.44% |
3 |
4/1/25 |
7/1/25 |
5.42% |
4.91% |
1.90% |
2.68% |
-1.07% |
3.5 |
10/1/25 |
1/1/26 |
5.13% |
4.72% |
na |
2.71% |
-0.91% |
4 |
4/1/26 |
7/1/26 |
4.83% |
4.58% |
1.85% |
2.74% |
-0.66% |
4.5 |
10/1/26 |
1/1/27 |
4.62% |
4.46% |
na |
2.76% |
-0.66% |
5 |
4/1/27 |
4/1/27 |
4.59% |
4.60% |
2.15% |
2.79% |
-0.56% |
The above yields assume you buy near the end of this month and then hold for the listed number of years or half years.
Several things to note from the last chart and table.
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The market inflation based I bond yield looks very good to hold for 1.5 years, ie not just the guaranteed 2 known 6 month periods, but the market is saying the next 6 month one (ie Apr’22-Oct’22) is going to be really high too. After that the yields for holding longer drop on average as the initially high historical inflation is diluted across a longer period of time with (expected) lower inflation.
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you can use it to decide, given your personal feelings about what constitutes a “good” yield, how long you are likely to hold an I bond bought this month. Let’s say you look at the market I bond column and decide that you think 5.5%+ is good, but for less than that, you’ll take your chances YOLO’ing NFLX options around earnings (pro tip: short). So that means you’ll want to hold for the 2.5 years worth of interest, ie 2.75 years including the 3 month penalty.
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Following up on the example in point #2, this might suggest you personally should want to buy up to $40k worth of I bonds, including $30k of gifts (say from your spouse and they v.versa) that use your 2022 allocation for the first $10k, as well as your 2023, 2024, and 2025 allocations to receive the additional $30k in gifts each following year. You can tell this because the maturity column in row 2.5 years is 1/1/25, meaning that’s when you’re planning on cashing out. Since that’s in 2025, you can use your gift allocation for all years up to and including 2025.
Side note - if you pay state or local income tax, you should adjust your “good enough” threshold for an I bond into a “tax-equivalent” yield. That is to say, the yield you would want from a fully state/local taxable bond to be equivalent to the I bond given you will take home more after-tax from the I bond.
- tax equivalent yield = (I bond yield) * (1 - federal marginal income tax rate) / (1 - fed and state combined marginal income tax rate)
So if you are in the 35% tax bracket federal and 10% local, you would take your I bond rate and multiply it by 0.65/0.55 = 1.18x to get the tax equivalent yield. So a 7.5% yield for the 1.5 year period would be worth 8.9% for a fully taxable bond in this situation. If you can deduct your state taxes in full on your federal itemized deduction (hard to do with the SALT cap these days), in principle you would reduce your effective state tax rate for this in the denominator.