By David Enna, Tipswatch.com
One hour after I was reading a Bloomberg report on inflation steadily easing in future months, the Bureau of Labor Statistics sent out a December surprise: Seasonally-adjusted inflation rose rose 0.3% for the month and 3.4% for the year.
Both those numbers were higher than expectations, and the same was true for core inflation, which removes food and energy. For the month, core inflation also rose 0.3% and ended 2024 at 3.9%.
This should be a bit of a shock to the U.S. stock market, which recently seems to have been celebrating the return of U.S. inflation to the Federal Reserve’s target of 2.0%. But the December report sent a different message: Inflation isn’t quite tamed yet.
This report sets the official 2023 U.S. inflation rate at 3.4%, down dramatically from the 6.5% of 2022 and 7.0% of 2020. But before that, inflation had not reached this level since 2005.
The BLS noted that shelter again was the key cause of higher inflation, with costs rising 0.5% for the month and 6.2% over the last year, and accounting for more than half of the all-items increase. More from the report:
- Gasoline prices crept 0.2% higher for the month but were down 1.9% for the year.
- The costs of food at home rose 0.1% and were up a moderate 1.3% for the year.
- The index for meats, poultry, fish, and eggs rose 0.5% in December, led by an 8.9% increase in the index for eggs.
- Electricity costs rose a sharp 1.3% for the month and were up 3.3% for the year
- Costs of used cars and trucks rose 0.5% in December but were down 1.3% for the year.
- New vehicle costs rose 0.3% for the month and 1.0% for the year.
- The motor vehicle insurance index rose 1.5% in December and was up a whopping 20.3% in 2023.
- Costs of transportation services rose 0.1% for the month but were up 9.7% for the year.
- The index for rent rose 0.4% for the month and 6.5% for the year.
Here is the trend in 2023 for all-items and core inflation, showing that core inflation has been inching steadily lower, while all-items costs have fluctuated:
What this means for TIPS and I Bonds
Investors in Treasury Inflation-Protected Securities and U.S. Series I Savings Bonds are also interested in non-seasonally adjusted inflation, which is used to adjust principal balances on TIPS and set future interest rates on I Bonds. For the month of December, the BLS set the inflation index at 306.746, a decrease of 0.10% from the November number.
Why was official inflation 0.3% and non-seasonal -0.10%? Keep in mind that seasonal and non-seasonal inflation balance out over the year and non-seasonal inflation tends to run lower from July to December and then higher from January to June. So expect a reverse of this trend beginning next month.
For TIPS. The December report means that principal balances for all TIPS will decline by 0.10% in February, after falling 0.20% in January. Here are the new February Inflation Indexes for all TIPS.
For I Bonds. The December report is the third in a six-month string that will determine the I Bond’s new variable rate, which will be reset on May 1 and eventually take effect for all I Bonds. So far, through three months, inflation has decreased 0.34%. The next three months are highly likely to reverse that negative number, but I would expect the end result to be less than 1.0%, which would result in a new variable rate around 1.72% for six months. Could it be higher? Maybe. Could also be lower. Lots can happen over the next three months.
As I have noted before, long-term I Bond investors should focus on the fixed rate, which is currently 1.3% for any purchase through April. The fixed rate is permanent and is historically attractive right now.
Here are the relevant numbers so far:
What this means for future interest rates
I’d expect some turmoil in the Treasury market today, with yields rising higher. This inflation report was higher than expectations across the board. The report certainly should reinforce the Federal Reserve’s determination to hold interest rates steady until inflation shows signs of abating. But it probably won’t mean much in the long run: The Fed has signaled three short-term rate cuts in 2024 and I’d expect that to happen.
From a Bloomberg report this morning:
“Inflationary pressures, while generally inching lower, remain stubbornly higher than expectations as the so-called ‘last mile’ requires more time to reach the final goal. The last Fed minutes underscored that the path towards price stability remains uncertain, and today’s CPI report suggests that the Fed’s initial rate cut may be later than the market is hoping for.”
Quincy Krosby, chief global strategist at LPL Financial
“Today’s inflation report reinforces the notion that the market had gotten a little overexcited around the timing of rate cuts. These are not bad numbers, but they do show that disinflation progress is still slow and unlikely to be a straight line down to 2%.”
Seema Shah, chief global strategist at Principal Asset Management
So it is possible that we won’t see a rate cut from the Federal Reserve in March, as many had anticipated. Figure June, instead?
This December inflation report should hold real yields around current levels through the Jan. 18 auction of a new 10-year TIPS. I will be posting a preview article about that auction on Sunday morning.
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
I went through your Jan. 24th, 2024 “TIPS Experiment” example of 91282B25 and could not match your Accrued Interest of $12.52. Please explain why my calculation doesn’t match your work.
Accd Int = ($12,000 Face Value x 1.30749 Inf Factor)/365 days x (46 days) =$12.36
In this case, $12.52 was the actual cost reported by Vanguard. I didn’t do any calculation for that total.
I did some research and was able to match the Accrued Int of $12.52.
Acc Int = Infl Factored Principalx(Int Rate over next 6 mo) x (days elapsed since most recent coupon pmnt & bond purchase settlement date) / (days between last coupon pmnt & upcoming coupon pmnt)
Acc Int = ($12,000 x 1.30749 x .00625/2) x 47/184 = $12.52
Looks like TIPS secondary market yields went slightly lower after the CPI reading. Those yields have declined further after today’s PPI measurement.
I am surprised, but as usual the bond market goes its own way. Not looking good for a 1.75% coupon rate at Thursday’s auction. We are probably getting a little “flight to safety” after attacks last night in Yemen. Treasury is offering $18 billion in that 10-year TIPS auction, largest ever for this maturity. I assume demand will hold up.
I think the “headlines” leave the wrong impression, because seasonally adjusted was up yet the month over month CPI-U was down and has been going down the last few months. If this does not turn around the buy in April is definitely the play for ibond.
I think this non-seasonal effect is the reason the Treasury has the I Bond rate-setting periods of April to September and then October to March. That way the non-seasonal CPI numbers cross over the end of year and balance out, more or less.
David, do you think there’s a chance the Treasury might raise the I Bond fixed rate in May to compensate for a (likely) much lower variable rate? Pure speculation, of course, but seems possible if real yields during the current rate-setting period hold near current levels for the next three months.
No. The fixed rate isn’t affected by the variable rate.
Hi David, with negative 0.34% inflation over the past three months, what is the reason you expect around +1.34% inflation for the next three months? If inflation doesn’t increase, then the 0% fixed rate I-Bonds purchased in 2021 and 2022 would be paying 0% for their next 6-month cycle. You’re probably right, I’m just curious why this is likely. Thanks.
Wondering about this as well. Even if monthly non-seasonal CPI increases 0.3% each of the next three months (which would not be consistent with 2% inflation), the 6-month change would be 0.56%. Wouldn’t this translate to a new variable rate of only 1.12%?
I did say “not much higher” than 1.0%, but you are right. If you figure that inflation averages 0.4% over the next three months, that only gets you to 0.86% and a variable rate of 1.72%. So I will be changing my wording. Thanks for the suggestion.
I see that you’re right about inflation tending to be higher early in the year. I just looked at the historical data and I see that inflation was up in January for 48 of the past 50 years, after being less than or equal to zero in 30 of the past 50 Decembers.
The December to January effect on non-seasonal inflation is one of the few “sure things” in economics. This is because the BLS adjusts for heavy discounting in November to December, but the non-seasonal number gets no adjustment.
Would you say it’s the other way around for the January to February numbers (almost always up) since all of the discounts are over? Also, the new (higher) prices for the new stuff?
Actually, it is just that in the October to December period, non-seasonal inflation will lag behind seasonally adjusted, and that turns around in January. This is because of the seasonal adjustments. So it isn’t a sure thing that prices will be up in January, but that non-seasonal will be higher than seasonally adjusted.
The Fed likes to talk about “green shoots” in the economy. I’m more concerned about the “blue sparks” of inflation like December’s 3.4% reading. I’m also troubled by the gap between seasonally adjusted and unadjusted numbers. Even with a 1.3% fixed rate, a negative inflation factor will mean a risk of earning 0% for second six months of that April I-Bond I was planning to buy. 😬
Did I detect some irony in your opening paragraph David? It seems we’ve all been reading the same report for a couple of years now, even before rate hikes began. First, inflation was transitory. Then, the Fed wouldn’t be able to raise rates too high, wouldn’t be able to hold them there, and be forced to cut sooner and deeper. The data upon which the Fed declares itself ‘dependent’ has consistently told a different story. And let’s not overlook the jobless claims number (202,000) released with today’s CPI. Up until mid-December the Fed has done a good job at least pretending to be ‘data dependent’. But something changed during Powell’s last news conference and I’m still trying to figure out what. To me, it’s looking more and more likely that the Fed’s pivot is based upon political considerations during an election year. If so, I’m worried that the Fed may cut DESPITE the data, not because of it.
Let’s hope the Fed maintains its independence and common sense because December’s jawboning alone has significantly eased market conditions, making a return to a 2% IR all the less likely.
I’ve been thinking the Fed “pivot” was more caused by the belief that interest rates are now high enough to keep inflation under control. But that does not mean cuts are necessary. Cuts are probably coming, given the Fed’s signals, but not as deep as the market is hoping for.
I hope you’re right. It’s just that the financial markets and media have been WAY TOO dovish and dismissive of inflation from the get-go. I can see plenty of things beyond the Fed’s control that can go awry (like oil prices).
Still, I have changed my outlook since Powell’s presser, buying I bonds when I was previously indifferent. As they say; you can’t fight them.
Hi- For I Bonds, this latest report makes the buy in April or buy in May decision more interesting.
If you’re a long-term buyer in 2024, an April buy is a no.brainer. Not only do you lock in a 1.3% fixed rate above inflation for up to 30 years, but you also lock in the 5.27% composite rate for the first 6 months.
I agree.