Anomaly Explains Puzzling Interest Rates for Series I Savings Bonds

Did the Bureau of Public Debt whip both inflation and high interest rates while we weren't looking?

You could get that impression from looking at the rates that took effect May 1 on Series I U.S. Savings Bonds. Those are inflation-protected savings bonds, which pay a rate that is a combination of prevailing interest rates and current inflation.

That combination, which had added up to 6.72 percent on bonds issued in the past six months, plunged to 2.41 percent for bonds issued beginning this month.

Great news for the economy, right?

Alas, no. The decline is in large measure a statistical quirk.

I Bonds, as they are called, pay a rate that is the sum of a fixed rate, set when the bond is issued and unchanged for the 30-year life of the bond, and the inflation rate, which is reset every six months.

The fixed rate is set administratively, based on the rates for Treasury Inflation-Protected Securities (TIPS), which are sold at auction. The rate on I Bonds takes into account such things as the fact that bondholders are allowed to defer taxes until they cash the bond. The new rate did go up -- to 1.4 percent from 1 percent in the previous six months -- just as you might expect from what is going on in the capital markets and the Federal Reserve.

However, the inflation component, which is based on CPI-U, the consumer price index for urban consumers, rose only a single percentage point. That may not jibe with your sense of what inflation is really doing, but it is what the index did.

From the end of September to the end of March, the index rose to 199.8 from 198.8, according to the Bureau of Public Debt, the Treasury Department agency that administers the savings bond program. That's roughly half a percentage point for six months, which they double to get an annual rate of 1 percent.

One percent plus 1.4 percent plus, one presumes, some rounding, equals 2.41 percent.

So, what happened?

First, inflation soared in the third quarter of last year, especially last September after the hurricanes that hit the Southeast. There was $3 gasoline then, too -- remember? Then, in the fourth quarter, prices dropped back. Further, changes in retailing, with the traditional after-Christmas sales vaulting ahead to become after-Thanksgiving sales, pushed prices down still more.