Inflation Protection Through Series I Savings Bonds
Series I Saving Bonds provide many of the benefits of TIPS, but may be even more beneficial during times of heightened inflation.
By Investment Associate Bobby Adusumilli, CFA.
In the book In Pursuit of the Perfect Portfolio, MIT Professor Andrew Lo interviews pioneering individuals in the investment industry - including Vanguard Founder John Bogle as well as Nobel Prize winners such as Eugene Fama and Robert Shiller - in order to answer a question that has captivated investors for generations: what is the perfect portfolio? While each interviewee gives hints as to what they consider the perfect portfolio, Andrew Lo ultimately concludes that there is no such thing as an everlasting perfect portfolio, writing, “Our Perfect Portfolio today is really just a snapshot of what’s best for you at the moment and in the current environment. Expected returns are ever evolving…. The pursuit of the Perfect Portfolio is all about adapting to our current income, our spending habits, our financial goals, the environment, and expected returns.“[1]
Nevertheless, the interviewees do provide some investments to consider. Andrew Lo writes, “If there is one specific asset that a majority of our authorities recommended for your Personal Portfolio, it’s TIPS (Treasury Inflation-Protected Securities). Inflation in recent years has been stable and low, but there is always the risk of macroeconomic change.“[1] TIPS are U.S. government-issued securities that generally increase in value with inflation and decrease in value with deflation, as measured by the nonseasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items.[2][3]
Source: FRED, as of July 31, 2022. See Important Disclosure Information.
Since the book came out in August 2021, U.S. inflation has risen significantly. As a result of this rise in inflation, TIPS (as measured by the Bloomberg U.S. TIPS Index 0-5 Years) have performed relatively well over the past year, outperforming the U.S. stock market (as measured by the Russell 3000) and the U.S. bond market (as measured by the Bloomberg U.S. Aggregate Bond Index), as shown in the below graph. However, because TIPS are subject to market demand as well as other structural features, TIPS have underperformed inflation (as measured by nonseasonally adjusted CPI-U) over the past year.
Sources: Dimensional Returns Web, U.S. Bureau of Labor Statistics. See Important Disclosure Information.
This lends the question: are there any investments that can provide more inflation protection than TIPS? Luckily, there may be.
Series I Saving Bonds provide many of the benefits of TIPS, but may be even more beneficial during times of heightened inflation.[4][5] Offered directly by the U.S Department of the Treasury through the treasurydirect.gov website, Series I Savings Bonds are 30-year government bonds designed to pay interest that matches (or even exceeds) inflation, as measured by the nonseasonally adjusted Consumer Price Index for all Urban Consumers (CPI-U) for all items.[4]
The interest on Series I Savings Bonds is composed of two parts: a fixed rate that lasts for the entire time that you hold the bond, and the inflation interest rate that resets every six months. The rates are set on May 1 and November 1, and you are guaranteed the stated inflation interest rate for the first six months that you hold the bond, and then you are guaranteed the next set inflation interest rate for the following six months, and so on. The interest rate on Series I Savings Bond cannot go negative (though a negative inflation rate can decrease your fixed rate for that six-month period to a minimum of 0%), which is beneficial considering that the specific CPI index includes the volatile food and energy sectors.[3][6]
You can choose to defer paying taxes on the monthly interest that you receive until you redeem the bond. The interest on Series I Savings Bonds is only subject to federal income taxes, not state or local income taxes. You can redeem Series I Savings Bonds directly with the U.S. government via the treasurydirect.gov website after one year, subject to some limitations listed below.[4]
While Series I Savings Bonds have many benefits, there are some drawbacks:[4]
Each eligible person and entity can only purchase up to $10,000 in Series I Savings Bonds per year, thus limiting usefulness for higher net worth people and entities.
Except in rare circumstances, you cannot redeem your Series I Savings Bond within the first year.
If you redeem your Series I Savings Bond within five years of purchase, you lose the most recent three months' worth of interest.
If you decide not to pay taxes on the annual interest while you hold the bond, then the year you redeem a Series I Savings Bond, you may add a significant amount to your federal taxable income, thus increasing your federal taxes in that year.
You must buy Series I Savings Bonds through the treasurydirect.gov website; you cannot buy through another custodian, and your financial advisor cannot buy these bonds on your behalf.
You can only specify one beneficiary (via the Registration List section on your treasurydirect.gov account) per Series I Savings Bond.
If inflation falls back to low levels, Series I Savings Bonds may pay little interest.
Prominent financial journalists including Jason Zweig, Christine Benz, and John Rekenthaler have written about Series I Savings Bonds in recent weeks, and it’s easy to see why given the current inflation interest rate of 4.81% for the first six months if you purchase prior to November 1, 2022.[4][7][8][9] We believe that Series I Savings Bonds can provide value for investors over the near-term as well as the long-term. Whether using for an emergency fund, saving for a big purchase such as a home, or wanting to add diversification to your overall investment portfolio, Series I Savings Bonds can provide a safe and stable way to save money while minimizing loss of U.S. dollar purchasing power. And if inflation ends up rising again in future years, then by accumulating Series I Savings Bonds over time, you can provide some stability and growth for your portfolio at a time when other investments may suffer.
Important Disclosure Information & Sources:
[1] In Pursuit of the Perfect Portfolio. Andrew Lo & Stephen R. Foerster, 2021, Princeton University Press.
[2] “Treasury Inflation-Protected Securities (TIPS)“. U.S. Department of the Treasury, Bureau of the Fiscal Service, treasurydirect.gov.
[3] “Consumer Price Index for All Urban Consumers: All Items in U.S. City Average“. Federal Reserve Bank of St. Louis, fred.stlouisfed.org.
[4] “Series I Savings Bonds“. U.S. Department of the Treasury, Bureau of the Fiscal Service, treasurydirect.gov.
[5] “Comparison of TIPS and Series I Savings Bonds“. U.S. Department of the Treasury, Bureau of the Fiscal Service, treasurydirect.gov.
[6] “Series I Savings Bonds Rates & Terms: Calculating Interest Rates“. U.S. Department of the Treasury, Bureau of the Fiscal Service, treasurydirect.gov.
[7] “Fight Runaway Inflation With I Bonds“. Jason Zweig, 29-Jul-2022, wsj.com.
[8] “Is It Too Late to Add Inflation Protection to Your Portfolio?“ Christine Benz, 22-Jul-2022, morningstar.com.
[9] “Run, Don’t Walk, for I Bonds“. John Rekenthaler, 10-Aug-2022, morningstar.com.
The Consumer Price Index for All Urban Consumers: All Items (CPIAUCSL) is a measure of the average monthly change in the price for goods and services paid by urban consumers between any two time periods. It can also represent the buying habits of urban consumers.
Russell 3000 TR USD Index is a market-capitalization-weighted index that measures the performance of the largest 3000 US companies representing approximately 98% of the investable US equity market.
Bloomberg US Aggregate Bond TR USD Index measures the performance of investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS.
Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) 0–5 Year Index is a market-weighted index measures the performance of inflation-protected public obligations of the U.S. Treasury that have a remaining maturity of less than five years
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this report that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Indices are not available for direct investment. Index performance does not reflect the expenses associated with management of an actual portfolio. Index performance is measured in US dollars. The index performance figures assume the reinvestment of all income, including dividends and capital gains. The performance of the indices was obtained from published sources believed to be reliable but which are not warranted as to accuracy or completeness.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
What Is Driving Inflation, And What Can You Do About It?
Global stock and bond markets have been tested by inflation many times in the past, and these markets have historically demonstrated their resilience in providing returns higher than inflation over time.
By Investment Associate Bobby Adusumilli, CFA.
It’s hard not to notice inflation these days - we see it in higher gas prices, higher grocery bills, and higher housing costs, among other areas. This is true beyond the U.S.: inflation rates in countries around the world are higher compared to recent history.[1]
For the one-year period ending May 31, 2022, the U.S. inflation rate (as measured by the CPI for All Urban Consumers Unadjusted Index) is 8.6%.[2] While most of the U.S. economy is experiencing some inflation, energy - which includes gasoline, oil, electricity, and other commodities - has experienced an outsized amount of inflation, approaching 35%.[2]
Source: “Consumer Price Index Summary“. U.S. Bureau of Labor Services, 10-Jun-2022, bls.gov. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. See Important Disclosure Information.
While these higher prices are difficult to handle right now, we believe there are some reasons for optimism regarding inflation. Energy prices spiked largely in response to effects from the COVID-19 pandemic as well as the war in Ukraine.[3] While we may experience elevated prices in the short-term, companies and markets tend to respond when there is high demand for a product, creating more competition and thus more supply, which should help constrain energy prices over time. Additionally, the Federal Reserve has been aggressively raising interest rates to combat inflation.[4] While this has hurt stock and bond prices recently, we believe this will help decrease inflation over time.[4]
Global bond markets are also expressing optimism that the U.S. inflation rate will fall back to more normal levels. For example, the 10-year breakeven inflation rate - which is a measure of what bond investors expect U.S. inflation to be over the next 10 years on average - is 2.33% as of June 30th, 2022.[5] While this is higher than the Federal Reserve’s goal of 2.00% inflation, bond markets do not expect medium- to long-term inflation to be anywhere close to the recent inflation rate.[5][6]
Source: FRED, as of June 30, 2022. The breakeven inflation rate represents a measure of expected inflation derived from 10-Year Treasury Constant Maturity Securities and 10-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 10 years, on average. See Important Disclosure Information.
Given all of this information, we have designed MarketPlus Investing portfolios to have some built-in inflation protection. For example, MarketPlus Investing model portfolios with fixed income allocations have exposure to U.S. Treasury Inflation-Protected Securities (TIPS) as well as short-duration (<5 years) bonds, which tend to provide some protection from inflation. And while global stocks can underperform inflation over the short-term (< 5 years), research has demonstrated that global stocks tend to provide inflation protection over the intermediate- (5-10 years) and long-term (10+ years).[7]
Investors looking for additional inflation protection can also consider purchasing Series I Savings Bonds, which are 30-year savings bonds offered by the U.S. government designed to match the Consumer Price Index for All Urban Consumers inflation rate. Each individual can buy up to $10,000 worth of these bonds per year, and you can sell after one year, subject to some conditions.[8] While SJS cannot buy these bonds for you directly, we are supportive of Series I Savings Bonds as potential investments for inflation protection. You can find additional information on the treasurydirect.gov website.
Global stock and bond markets have been tested by inflation many times in the past, and these markets have historically demonstrated their resilience in providing returns higher than inflation over time.[7] While it may be difficult in the short-term, we believe that staying invested is the key to getting through this market volatility and inflation.
Important Disclosure Information & Sources:
[1] “Inflation Rate - By Country“. Trading Economics, June 2022, tradingeconomics.com.
[2] “Consumer Price Index Summary“. U.S. Bureau of Labor Services, 10-Jun-2022, bls.gov.
[3] “How High Is Inflation and What Causes It? What to Know“. Gabriel T. Rubin & David Harrison, 10-Jun-2022, wsj.com.
[4] “Fed Raises Rates by 0.75 Percentage Point, Largest Increase Since 1994“. Nick Timiraos, 15-Jun-2022, wsj.com.
[5] “10-Year Breakeven Inflation Rate“. Federal Reserve Bank of St. Louis, 30-Jun-2022, fred.stlouisfed.org.
[6] “Why does the Federal Reserve aim for inflation of 2 percent over the longer run?“ Board of Governors of the Federal Reserve System, 27-Aug-2020, federalreserve.gov.
[7] Stocks for the Long Run. Jeremy Siegel, 2014, McGraw Hill.
[8] “Series I Savings Bonds”. U.S. Department of the Treasury, June 2022, treasurydirect.gov.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this report that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
MarketPlus Investing® models consist of institutional quality registered investment companies. Investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
The Topic That Keeps Rising To The Top: Inflation
Before worrying too much about runaway prices and the inability to pay the rising costs, we believe it’s important to look at a few underlying factors.
By SJS Investment Services Chief Investment Officer Tom Kelly, CFA.
As the summer vacations and barbeques kick back into full swing, one conversation topic continues to rise to the top – inflation. Thankfully for many of us, gone are the days of masks, social-distancing, and awkward elbow bumps. The new “fear” is now, “Are things in the economy too good?” What a difference a year makes!
In last quarter’s SJS Outlook, our headline piece asked, “Inflation: Necessity or Risk? And What Should We Do?” Since then, inflation has continued to rise, as we’ve seen year-over-year inflation rates come in at 4.9% in May 2021 and 5.3% in June 2021, leading to continued questions and worries of “hyperinflation.”[1] However, before worrying too much about runaway prices and the inability to pay the rising costs, we believe it’s important to look at a few underlying factors.
As I mentioned earlier, what a difference a year makes. If you think back to all the uncertainty, and therefore lack of spending, that existed in Spring 2020, you would not be surprised to know that inflation was falling and near zero at this point last year. The year-over-year inflation numbers, which make the headlines, look a bit magnified because of where we were last year. When looking at prices compared to “pre-pandemic” levels, by observing annualized inflation over the last two years, inflation was only 3.0% in June 2021.[1]
“Consumer Price Index for All Urban Consumers: All Items in U.S. City Average”. U.S. Bureau of Labor Statistics, June 2021, fred.stlouisfed.org.
Additionally, when breaking down some of the components of inflation, indications point to some of the main causes of the recent rise as more transitory vs. pervasive. As of June 2021, areas such as airline fares (up 25% from a year ago) and used cars & trucks (up 45% from a year ago, due largely to a chip shortage) suggest that pent-up demand and temporary supply chain bottlenecks will lead to the dramatic rises being short-lived rather than enduring.[2][3]
We welcome the continued growth of the economy and potential of increased inflation as opposed to the alternate reality of stagnation and weak economy. Could inflation become a major problem? Certainly. Do we think inflation is a major problem right now? Probably not. Should you make drastic moves to ward it off? Not prudent in our opinion.
As Mark Twain purportedly said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” We continue to be humble about what we don’t know – the direction of inflation and corresponding market movements included – and focus on what we can control: designing portfolios to help you achieve your financial goals and putting you first. All the time. Every time.
Important Disclosure Information & Sources:
[1] “Consumer Price Index for All Urban Consumers: All Items in U.S. City Average”. U.S. Bureau of Labor Statistics, June 2021, fred.stlouisfed.org. US Bureau of Labor Statistics Consumer Price Index All Urban Seasonally Adjusted is a measure of the average monthly change in the price for goods and services paid by urban consumers between any two time periods. It can also represent the buying habits of urban consumers. This particular index includes roughly 88 percent of the total population, accounting for wage earners, clerical workers, technical workers, self-employed, short-term workers, unemployed, retirees, and those not in the labor force.
[2] “Consumer Price Index for All Urban Consumers: Airline Fares in U.S. City Average“. U.S. Bureau of Labor Statistics, June 2021, fred.stlouisfed.org.
[3] “Consumer Price Index for All Urban Consumers: Used Cars and Trucks in U.S. City Average“. U.S. Bureau of Labor Statistics, June 2021, fred.stlouisfed.org.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this report that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
Inflation: Necessity or Risk? And What Should We Do?
We believe economic inflation is a real risk - the other edge of the sword in contrast to the risk of stock-market volatility that is so often referenced in investment-risk discussions.
By SJS Investment Services President Kevin Kelly, CFA.
Have you ever had a flat? Re-inflating the tire is a good thing!
Ever over-inflated a tire? Or a balloon? Not so good!
Coming off the severe economic disruption from the early months of the COVID pandemic, you could justifiably argue that daily commerce had a flat tire - or four!
Never fear! Our duly elected leaders in Washington of BOTH parties were ready to help - a few trillion dollars in stimulus payments ought to do the trick!
A classic characterization of economic inflation, or its cause, is “too many dollars chasing too few goods.”
Of course, it is never quite that simple.
While “Money Supply” has increased measurably from this time one year ago, significant slack remains in our U.S. economy such that the “Velocity of Money,” or how frequently a dollar changes hands, has plummeted from the pre-pandemic rate. Both have an influence on inflation.[1][2]
Source: “Inflation, consumer prices for the United States“. Federal Reserve Bank of St. Louis, 03-Mar-2021, research.stlouisfed.org.
Anecdotally, we can point to price increases in housing, automobiles, some groceries, and fill-in-the-blank here based on your personal experience. Asset prices have increased as reflected by the stock market.[3] Producer Price Indices have surged, but this may not sustain as supply chains recover and stabilize.[4] The value of a dollar is on a downward trend compared to many foreign currencies.[5] The “breakeven inflation rate” indicated by the U.S. Treasury bond market suggests a 10-year rate of inflation approaching 2.4%, the highest this indicator has been in about eight years.[6]
But “what to do” quickly becomes the punchline, whether you anticipate inflation or not. SJS professionals believe economic inflation is a real risk - the other edge of the sword in contrast to the risk of stock-market volatility that is so often referenced in investment-risk discussions.
A primary motivation for taking investment risk to begin with is to maintain and grow the purchasing power of your assets. With cash deposits receiving close to a zero-percent rate of return, a general inflation rate of 2.4% will erode your purchasing power in a meaningful way over a period of years unless you invest beyond cash.
We recently “benchmarked” our model portfolios against the Consumer Price Index (CPI) to demonstrate
this inflation-beating characteristic of our investment strategies.
Benchmark: “Consumer Price Index for All Urban Consumers: All Items in U.S. City Average (CPIAUCSL)”. Federal Reserve Bank of St. Louis, 31-Mar-2021, research.stlouisfed.org. See Important Disclosure Information.
Your MarketPlus Investing® design has allocations to inflation-adjusted bonds and inflation-hedging stocks for environments such as our current one. No hedge or adjustment is perfect, and inflation can put stress on your household budget no matter what. But as “professional worriers,” planners, and managers, your team at SJS has anticipated inflation and works daily on your behalf to align your investments with current valuations, our outlook on the markets, and your best interests.
We can all agree that a flat tire or a stalled economy is not a desirable state of affairs. Let’s hope the government stimulus spending, a resurgent economy, and inflationary dynamics find the right balance and keep us on a steady road of progress in the quarters and years ahead!
Important Disclosure Information And Sources:
[1] “M2 Money Stock (M2SL)“. Federal Reserve Bank of St. Louis, 25-Mar-2021, research.stlouisfed.org.
[2] “Velocity of M2 Money Stock (M2V)“. Federal Reserve Bank of St. Louis, 25-Mar-2021, research.stlouisfed.org.
[3] “MSCI ACWI IMI Index (USD)“. MSCI, 31-Mar-2021, msci.com.
[4] “Producer Price Indexes (PPI)“. Federal Reserve Bank of St. Louis, 25-Mar-2021, research.stlouisfed.org.
[5] “Foreign Exchange Rates - H.10“. Board of Governors of the Federal Reserve System, 05-Apr-2021, federalreserve.gov.
[6] “10-Year Breakeven Inflation Rate (T10YIE)“. Federal Reserve Bank of St. Louis, 31-Mar-2021, research.stlouisfed.org.
Past performance does not guarantee future results.
SJS Investment Services (SJS) has created hypothetical performance returns for each of its MarketPlus® Asset Allocation Models. The hypothetical performance was calculated by applying the actual performance of a mutual fund to the asset class percentage within a MarketPlus® Asset Allocation Model. The Model Portfolio Historic Returns do not reflect actual trading or the performance of actual accounts. Actual client results may be materially different than the hypothetical returns. All returns presented include reinvestment of dividends and other earnings. The hypothetical results presented reflect the deduction of a 1.10% annual SJS advisory fee, the maximum fee charged. Advisory fee may be less than illustrated. Performance may be reduced by other fees charged by your custodian. The effect of fees and expenses on performance will vary with the relative size of the fee and account performance. Please refer to Part 2A of SJS’ Form ADV for additional information on SJS’ advisory fees.
There are inherent risks in the presentation of hypothetical performance data because the data may no t reflect the impact of material economic and market factors. The results presented reflect the effect that material market and economic conditions had on the actual performance of the underlying mutual funds but does not reflect the impact that these factors might have had on decision-making.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
Is Your Cash Keeping Up With Inflation?
Cash management remains vital to both risk mitigation and capital preservation. How can you increase your expected return via cash-like holdings?
By SJS Investment Services Chief Investment Officer Tom Kelly, CFA.
The adage “Cash is King” has been used in investing to highlight the value of holding on to cash to both protect an investor from having to withdraw when the markets are down, as well as the ability to deploy cash and purchase when prices become cheaper. However, over the last decade, with interest rates kept low near the anchoring Fed Funds rate, inflation has outpaced the interest rate on cash, leading to that cash losing its spending power over time.[1]
In the US, the erosion of cash value has been greater in recent times than previous periods, with cash trailing inflation since 2009, seen below. We believe this trend is likely to continue, with the Federal Reserve indicating they will continue to keep interest rates near 0%, all the while continuing to provide stimulus to the economy, leading to a 5-Year Breakeven Expected Inflation Rate of 2.35% as of February 23, 2021.[2][3]
Source: Morningstar. Cash represented by the US Treasury T-Bill Secondary Market 3 Month Rates. Inflation represented by the US Bureau of Labor Statistics Consumer Price Index All Urban Seasonally Adjusted Index. See Important Disclosure Information.[4]
Cash management remains vital to both risk mitigation and capital preservation. How can you increase your expected return via cash-like holdings? Online banks sometimes offer higher savings account interest rates than traditional banks due to their lower fixed physical costs. Depending on the holding time horizon, cash alternatives may include Treasury Inflation-Protected Securities (TIPS) or other higher-quality short-term bonds. Furthermore, both real estate and stocks have historically significantly outperformed inflation over the long-term, though they typically add significantly more volatility over the short-term.[5]
Prudent cash management can add incremental value to your overall portfolio investment return. If you have any questions regarding your cash management, please feel free to reach out to us.
Important Disclosure Information And Sources:
[1] “How Inflation Affects Your Savings Account.“ Justin Pritchard, 07-Jan-2021, thebalance.com.
[2] “Powell Pledges to Maintain Fed’s Easy-Money Policies Until Economy Recovers.” Paul Kiernan, 24-Feb-2021, wsj.com.
[3] “5-Year Breakeven Inflation Rate.” Federal Reserve Bank of St. Louis, 23-Feb-2021, fred.stlouis.org. The breakeven inflation rate represents a measure of expected inflation derived from 5-Year Treasury Constant Maturity Securities and 5-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 5 years, on average. See Important Disclosure Information.
[4] The US Treasury T-Bill Secondary Market 3 Month Rates are the daily secondary market quotation on the most recently auctioned Treasury Bills for the 13 week maturity for which Treasury currently issues new Bills. Market quotations are obtained at approximately 3:30 PM each business day by the Federal Reserve Bank of New York. The rate at which a Bill is quoted in the secondary market and is based on the par value, amount of the discount and a 360-day year.
The US Bureau of Labor Statistics Consumer Price Index All Urban Seasonally Adjusted is a measure of the average monthly change in the price for goods and services paid by urban consumers between any two time periods. It can also represent the buying habits of urban consumers. This particular index includes roughly 88 percent of the total population, accounting for wage earners, clerical workers, technical workers, self-employed, short-term workers, unemployed, retirees, and those not in the labor force.)
[5] Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies. Jeremy Siegel, 2014, McGraw-Hill Education.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Advisory services are provided by SJS Investment Services, a registered investment advisor with the SEC. Registration does not imply a certain level of skill or training. This material has been prepared for informational purposes only.
Statements contained in this post that are not statements of historical fact are intended to be and are forward looking statements. Forward looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
How Will Inflation Impact Your Portfolio?
Since expected U.S. inflation is now near the long-term target of 2.00%, we think it is reasonable to expect that interest rates will remain near current levels.
History and Signaling Suggest Both Inflation and Interest Rates Will Remain Low
By SJS Investment Associate Bobby Adusumilli.
The Federal Reserve of the United States of America (the Fed) has a dual mandate: to maximize employment and to stabilize prices for goods and services. To pursue this mandate, the Fed believes that a 2.00% increase in annual inflation is most appropriate in the long run.[1]
While the Fed cannot completely control inflation, the Fed influences inflation by setting a target Federal Funds Rate (the rate at which banks borrow money from the government) and more directly changing the amount of money circulating in the economy in order to push the current Federal Funds Rate to the desired rate.[1] Consequently, while the Fed doesn’t directly control most other interest rates, shorter-term interest rates (< 1 year) generally follow changes in the Federal Funds Rate, and longer-term interest rates (>= 10 years) tend to follow as well (though with more variability).[2]
Source: “A Look at the Fed’s Dual Mandate.” Federal Reserve Bank of St. Louis, 08-Aug-2018, stlouisfed.org.
When inflation is higher (lower) than the Fed targets, the Fed will typically aim to decrease (increase) the money supply in the economy, which consequently typically increases (decreases) both the Fed Funds Rate and other interest rates, with the goal for individuals to spend less (more) and save more (less).[1]
As of September 30, 2020, the Fed projects inflation to average 1.79% over the next five years, close to the long-run target of 2.00%.[1][3] As illustrated in the graph below, the Fed has worked over the past 50+ years to influence (primarily to decrease) inflation to that 2.00% goal, significantly through affecting interest rates.
Sources: Morningstar, FRED, as of 30-Sep-2020. Interest Rates: 3-Month Treasury Bill: Secondary Market Rate (TB3MS); Inflation: Consumer Price Index for All Urban Consumers: All Items in U.S. City Average (CPIAUCSL).
Generally (all else equal), as interest rates decrease, prices of existing bonds increase, partially because of increased investor demand for higher-yielding investments. Much of the strong returns for US bonds over the past 40 years is due to positive price changes caused by generally declining interest rates.[4]
However, since expected inflation is now near the long-term target, we think it is reasonable to expect that interest payments, not price changes, will drive the majority of positive bond returns over the next 10+ years, and that interest rates will remain near current levels. This provides significant justification for why SJS projects a 2.50 – 3.50% return for US aggregate bonds over the next 10+ years (as further detailed in the SJS 2020 Capital Market Expectations). Using these return expectations as part of the MarketPlus Investing approach allows SJS to help clients develop portfolios designed to meet their current and future needs.
If you would like to talk about how inflation and interest rates may impact your lifestyle and investment portfolio, please reach out to us. We are always here to listen and assist.
Important Disclosure Information and Sources
[1] “How does the Federal Reserve affect inflation and employment?“ The Federal Reserve, federalreserve.gov.
[2] “Monetary Policy Actions and Long-Term Interest Rates.“ V. Vance Roley and Gordon H. Sellon, Jr., Q4 1995, kansascityfed.org.
[3] “5-Year Forward Inflation Expectation Rate.“ Federal Reserve Bank of St. Louis, 30-Sep-2020, fred.stlouisfed.org.
[4] “An Appreciation for the Bull Market in Long-Term Bonds.“ Ben Carlson, 16-Aug-2019, awealthofcommonsense.com.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
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