Fixed rate on I-bonds takes a buzz cut

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The U.S. Treasury was expected to cut the fixed interest rate on inflation-indexed savings bonds today. And cut they did -- all the way to zero.

I-bonds, as they’re called, earn a combination of a fixed rate, which holds steady for the 30-year life of the bond, and the inflation rate as measured by the Consumer Price Index. The inflation component is adjusted each May 1 and Nov. 1, and the Treasury also has the option of changing the fixed rate on new bonds on those dates.

Today’s announcement was a shocker: I-bonds sold between now and Oct. 31 will have a zero fixed rate, down from 1.2% on I-bonds sold in the last six months.

The inflation component of the return still is attractive: It will be an annualized 4.84% for the next six months, thanks to the recent surge in the CPI. But imagine that inflation ebbs again in the next few years. With a zero fixed rate on new I-bonds, your return could dwindle, even to nothing at all.

A Treasury spokeswoman in Washington said the fixed rate on I-bonds was cut based on a formula that takes into account rates on the government’s inflation-indexed Treasury notes. ‘It’s just the way the formula works out,’ she said.

Series EE bonds, which pay a fixed rate, also took a big haircut today: Newly purchased EE bonds will pay just 1.4% a year, down from 3.0% on bonds bought in the last six months. So new EE bonds are paying less than six-month T-bills, which yield 1.61%.

Dan Pederson, author of ‘Savings Bonds: When to Hold, When to Fold,’ sees a disturbing trend here. ‘I think the government has been looking for some time to push people away from Savings Bonds and into regular Treasuries,’ he says. As for I-bonds in particular, Pederson says that with a zero fixed rate, they’re now only appealing ‘if you think inflation is going to spiral out of control.’

Posted May 1, 2008