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URL:  https://boards.fool.com/ltin-october-2008-with-asset-values-of-almost-29802931.aspx

Subject:  Re: 3.06% rate for tax-deferred I-Bonds Date:  1/25/2012  12:29 PM
Author:  WendyBG Number:  33614 of 37043

<In October 2008, with asset values of almost everything melting down, TIPS were commonly priced to yield close to 3% at a time when the fixed rate on new I bonds was zero. In that scenario I would say TIPS were a much better choice for new money. >

I agree with you, ziggy. In October 2008, I invested heavily in TIPS but did not buy new I-bonds although I kept my 2001 I-bonds that yield 3% + inflation.

This is such an important point that I will summarize a general rule:

The market is expressing an opinion about long-term inflation when it prices TIPS. It is also expressing an opinion about the long-term market supply/demand ratio for Treasury debt, whether or not the specific instrument is inflation-adjusted.

I have been studying TIPS for years. The yield of Treasuries has always been higher than the yield of TIPS, because inflation was always positive. Since TIPS were first sold by the government, the bond market consistently underestimated the actual CPI-U inflation rate (as expressed in the spread between TIPS and Treasuries).

In October-December 2008, the yields inverted and the spread became negative. This unprecedented inversion said that the market expected deflation to last over the remaining life of the bond.

This is where personal judgment came into play. Fed Chairman Ben Bernanke gave a speech in 2002 saying that a Fed Chairman had the powerful tool of a "helicopter dropping money" to reverse deflation so "IT would not happen here."

In my judgment, a severe recession could cause deflation (as Mike Shedlock predicted), but in my opinion this would be short-lived. I bought 10-year TIPS because I believed then (and now) that the Fed and Treasury will massively increase the money supply, causing inflation.

TIPS have a large, liquid market (though much smaller than Treasuries). The time to buy TIPS (relative to Treasuries) is when the market underestimates future inflation.

I-Bonds are a different story. The government sets yields, not the market. Until a few years ago, an individual or trust could buy up to $30,000 of paper I-Bonds plus<i/> and additional $30,000 of electronic I-Bonds. Since each bond is issued to an individual, it cannot be sold in the market (like TIPS). If redeemed before maturity (over one year of hold time), it is redeemed at face value even if prevailing interest rates have risen, which would cause a TIPS bond to drop in value.

Unfortunately, Savings Bonds are no longer a worthwhile investment. They can only be bought electronically in relatively small amounts. The yields are disappointingly low.

Wendy

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