Unpacking the Fed Raising Interest Rates, Inflation, and I Bonds
Image via AARP
THE FED HAS RAISED INTEREST RATES BY 0.50%
THE LARGEST MOVE SINCE 2000
What happened today and why is it important?
It doesn't take much to see that Inflation is everywhere today. It's made its way into our grocery stores, gas stations, restaurants, and every used car dealership across the county. In an effort to curb inflation, the Federal Reserve, led by Chairman Jerome Powell decided to take action in their most aggressive step yet by raising interest rates by half a percentage point today. Here are his comments on today's decision:
"Inflation is much too high and we understand the hardship it is causing. And we are moving expeditiously to bring it back down... It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all.
Friday's move came as no surprise and we expect to see additional rate hikes in the coming months. The Fed announced that it anticipates rates going up to 2% by the end of July; thus indicating (2) more full 0.50% rate hikes in June and July.
What caused U.S. stocks to rally today was that the Fed stuck to it's original script of raising rates only by 0.50% and did not surprise Markets with a 0.75% rate hike. Chairman Powell commented that the Fed wasn’t “actively considering” raising interest rates by 0.75 percentage points at a future meeting. More importantly, Powell's comments signaled confidence for market's that the Fed is not trying to unnecessarily spook markets, but rather is choosing to approach these rates hikes and other Quantitative Tightening measures with caution.
All things considered, we have now officially left the era of Quantitative Easing (QE) from 2008/09 period where rates were dropped to nearly zero for over six years in an effort to rescue the U.S. Economy from the Global Housing Crisis. And are now entering a new environment with higher interest rates that reflect those of more normal, historical figures.
To quote Warren Buffett from his Berkshire Hathaway shareholders meeting this past weekend relating to inflation:
"Nobody knows how much inflation will be in the next 50 years or the next month. There is a lot of curiosity around that question and people may say they know the answer but no one really knows.
Instead, the best thing you can do is to be exceptionally good at something. "Whatever abilities you have can't be taken away from you. They can't actually be inflated away from you. ... So the best investment by far is anything that develops yourself, and it's not taxed at all."
We understand that the financial markets are ever-changing and that is only exacerbated during a time when inflationary pressures are at the forefront. Therefore, it is important to have a well-diversified portfolio, know what you're invested in, and ensure your goals still match your portfolio.
As I've said before, financial planning is an ongoing process and your plan will shift, move and adjust as life and circumstances change. As it relates to inflation and your portfolio, I do have some specific thoughts about how to add some additional value in your portfolio during these times. One of which I'd like to share below.
THE USE OF SERIES I BONDS IN YOUR PORTFOLIO
First, what is an I-Bond? No, it's not made by Apple and isn't an App you can download for your iPhone.
An I-Bond is a short-term bond, backed by full faith and guarantee of the U.S. Federal Government. By being backed by the US. Government means these bonds are effectively risk-free and inflation protected.
Interest Rates on these bonds change every six-months based off of Inflation (CPI) figures. The Treasury Department recently announced that it would be paying 9.62 percent until the end of October.
Though chasing rates and returns are rarely encouraged, now may be a good time to consider purchasing some I-Bonds.
When inflation is running wild like it is now, at least I-Bonds will keep pace with inflation.
Here's what you should know about this type of saving bond before determining if it's appropriate for you:
How is the Interest rate determined?
There are two components to the return for the bond — the fixed rate and the inflation rate. The fixed rate, which right now is zero percent, stays the same for the life of the bond. However, the inflation rate changes, every six months. The inflation rate component is based on changes in the Consumer Price Index for all Urban Consumers (CPI-U).
For I bonds issued from May 2022 through the end of October 2022, the overall rate is 9.62 percent.
2. How much can I purchase in I-Bonds?
Each individual is limited to $10,000 per calendar year. If you are married, then you would qualify for $20,000 worth of eligible purchases (2 x $10,000).
If you have children, they count as well towards the amount you are eligible to purchase.
3. Are I-Bonds taxable?
Yes, you will have to pay federal income taxes on the interest you earn but interest earned is exempt from state and local income taxes.
4. Are there any time constraints or requirements?
You can cash your Series I bonds any time after 12 months. You receive the original purchase price plus interest earnings. I bonds are meant to be longer-term investments; if you redeem an I bond within the first 5 years, you'll lose your last 3 months interest. For example, if you redeem an I bond after 18 months, you'll receive the first 15 months of interest
5. Who does this make sense for? Where may this fit into my financial plan?
I-Bonds are designed to be treated as an excess Emergency Funds replacement. In other words, if you find yourself not needing the money for at least 12 months and want to earn a higher rate of return than either your Savings Account or a CD, then this may make sense for you.
Disclaimer: The views and opinions expressed are made as of the date of publication and are subject to change over time. The content of this website is for informational or educational purposes only. Website content is not intended as individualized investment advice, or as tax, accounting, or legal advice. It is not intended to be a recommendation or endorsement to buy or sell the specific investment. This information should not be relied upon as the sole factor in an investment-making decision. Website users are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.