Predicting inflation

As a conservative investor, I have a ladder of CDs and bonds which are continually maturing, freeing cash to be rolled over into the most advantageous interest-yielding instrument which is non-callable and has zero default risk. These are:
Treasuries, which have duration risk.
TIPS, which have both duration and inflation rate risk.
CDs, which have no risk if held to maturity, significant sacrifice of interest if redeemed before maturity.
I-Bonds, which have no duration risk if held more than one year, sacrifice of 3 months interest if sold before 5 years and inflation rate risk.

If inflation is higher than predicted, the inflation-adjusted TIPS and I-Bonds would have an advantage over fixed yield instruments.

The bond market predicts inflation by the spread between the Treasury and TIPS of the same duration. The bond market is very confident that inflation will be under 2.5% for the next 5 to 10 years.

Wells Fargo predicts that inflation will be 2.4% in January 2024.

Statista predicts a similar path.

Maturity CPI Statista Inflation Statista
2021 271
2022 292 7.75%
2023 300 2.74%
2024 306 2.00%
2025 313 2.29%
2026 319 1.92%
2027 326 2.19%

The bond market expects that the Federal Reserve will cut interest rates as quickly as possible. The combination of this expectation, the banking crisis and gradually falling inflation has led the yield curve to drop suddenly.

Because of this expectation, I am looking at 5 year durations or even more. I clearly recall how interest rates dropped suddenly in 2020. The “transitory” high inflation in 2022-2023 may be an opportunity to lock in higher yields before the Fed cuts again. The inverted yield curve means that every year longer duration yields less. has a good discussion.
What about I Bonds? We are going to get a reset on both the fixed and variable rates for the U.S. Series I Savings Bond on May 1. The variable rate will probably fall to a range of about 3.2% to 3.5%, down dramatically from the current 6.48%. The fixed rate looks likely to hold at around 0.4%, I think, or just a bit higher. [end quote]

I agree with this assessment. Does it make sense to buy a I-Bond with the intention to hold it for 5 years when a TIPS with a 5 year maturity yields 1.2% (plus inflation)? The benefit of the I-Bond is the flexibility of the holding period. Return of principal is always assured with an I-Bond, which isn’t the case for a TIPS which is sold before maturity. On the other hand, if interest rates fall, the TIPS could yield a capital gain, which the I-Bond cannot.

If the market’s expectation of inflation is correct, secondary-market CDs are yield more than TIPS. (Data from Fidelity.)

Maturity New CD Secondary CD TIPS Secondary CD minus TIPS CPI Statista Inflation Statista
2021 271
2022 292 7.7%
2023 300 2.7%
2024 306 2.0%
2025 4.6 4.7 1.5 3.2 313 2.3%
2026 4.5 4.7 1.4 3.3 319 1.9%
2027 4.5 4.7 1.3 3.4 326 2.2%
2028 4.4 4.6 1.2 3.4
2029 4 3.3 1.1 2.2
2030 3.95 1

If inflation remains higher than the market’s expectation the picture changes. The Fed has been wrong about inflation’s tenacity before and they may be again.



Interesting data (and times).

It seems that we may have seen peak rates for 2 to 10 year Treasurys, which had the 2 year up to 5% and the 10 year up to 4% (talk about transient!).

Employment situation is good, but weakening.
Consumers are cautious.
Banks are showing stress.
Commercial real estate showing stress.

Difficult to see a case for the Fed funds rate going higher, one could easily argue for a pause now. After all, what does an incremental 25bp get us anyway? Not much given that we are at about 5% now.


I don’t see how it could possibly make sense. The I-bond will yield ~0.4+CPI, while the TIPS will yield ~1.2+CPI. Sure the I-bond’s first period might be a bit higher, and while it’s possible the TIPS might have one or two negative CPI months which get recorded as 0.00 for the I-bond, those are very rare and not likely. And I suppose you can also account for the fact that buying an I-bond at the end of the month earns interest from the first of the month, but I don’t think any of that can overcome a yield advantage of roughly 5 x (1.2 - 0.4) = 5 x 0.8 = ~4% over 5 years.

That said, I-bonds may make sense for other reasons. If you buy an I-bond, in 5 years you can choose if you want it to remain longer, for 10 years, or 20, or even 30. If you buy a 5-year TIPS, it WILL mature in 5 years and the money will be deposited into your account, end of story. And I-bonds have certain esoteric tax advantages that TIPS do not. And TIPS have phantom interest that is taxed each year, I-bonds do not. And you can choose (kind of) when I-bond interest tax will be paid (can either choose each year, or all at once at the end).


I think this is a few misnomers or false assumptions. I do believe the reporters would say this.

The main reason for the bond buying is a flight to safety. It is ironic after Yellen devised her Operation Twist for when the foreign institutions sell the US paper to buy their respective currencies that the public globally would want US paper anyway. I did not see that coming.

That is also why the equity markets are taking their time to fall. The world is slightly more bullish right in here now on the US than anything else.