I Bond Fixed Rate Prediction: What to Expect for the Next 6 Months

I Bonds have gained attention as a safe investment that protects against inflation, but their fixed rate component remains unpredictable. This rate, which stays constant for the life of the bond, is adjusted every six months and can significantly impact long-term returns. With an upcoming reset, many investors are eager to understand what might happen next.

How the Fixed Rate Is Determined

The fixed rate of an I Bond is set by the U.S. Department of the Treasury and reflects broader financial conditions at the time of issuance. Unlike the inflation-adjusted component, which changes every six months based on the Consumer Price Index for All Urban Consumers (CPI-U), the fixed rate remains unchanged for the life of the bond. This makes it an important factor for long-term investors.

To establish this rate, the Treasury considers prevailing interest rates in the broader bond market, particularly Treasury securities with similar durations. The 10-year Treasury yield is a key reference point, as it provides insight into long-term borrowing costs for the government. When these yields rise, the Treasury may increase the fixed rate on I Bonds to keep them competitive. Conversely, when yields fall, the fixed rate tends to decrease, making I Bonds less attractive compared to alternatives like certificates of deposit or high-yield savings accounts.

Demand for I Bonds also plays a role. When demand is high, the Treasury has less incentive to offer a generous fixed rate, as seen in late 2021 and early 2022 when record sales coincided with a low fixed rate. When demand weakens, the Treasury may raise the fixed rate to encourage more purchases.

Economic Indicators That Shape the Rate

Several economic factors influence the fixed rate of I Bonds. While the exact formula remains undisclosed, analyzing key indicators provides insight into potential adjustments.

Treasury Yield Data

Treasury yields reflect the return investors demand for lending money to the U.S. government. The 10-year Treasury note is particularly relevant because it serves as a benchmark for long-term interest rates. When yields rise, the Treasury may increase the fixed rate on I Bonds to ensure they remain competitive.

In early 2024, the 10-year Treasury yield fluctuated between 4% and 4.5%, a significant increase from the sub-1% levels seen in 2020. If this trend continues, the Treasury could justify a higher fixed rate. The 5-year Treasury note also provides context on interest rate expectations. A steep yield curve—where long-term rates are significantly higher than short-term rates—suggests that investors anticipate rising rates, which could pressure the Treasury to offer a more attractive fixed rate.

Inflation Indexing

While the fixed rate of I Bonds does not change with inflation, broader inflation trends still influence its determination. The Treasury considers inflation expectations when setting the fixed rate, as higher inflation generally leads to higher interest rates across financial markets. The Federal Reserve’s preferred inflation measure, the Personal Consumption Expenditures (PCE) index, along with the Consumer Price Index for All Urban Consumers (CPI-U), provide insight into price trends.

If inflation remains persistent, the Federal Reserve may keep interest rates elevated, indirectly affecting Treasury yields and, by extension, the fixed rate on I Bonds. In 2022, when inflation exceeded 8%, the Federal Reserve aggressively raised the federal funds rate, contributing to higher Treasury yields. If inflation moderates but remains above the Fed’s 2% target, the Treasury might still opt for a modest increase in the fixed rate to reflect the higher-rate environment.

Market Liquidity

Liquidity conditions in financial markets also influence the fixed rate. When liquidity is abundant, demand for safe assets like Treasury securities tends to rise, pushing yields lower. Conversely, when liquidity tightens, investors demand higher returns, which can lead to increased Treasury yields and potentially a higher fixed rate on I Bonds.

One measure of liquidity is the Federal Reserve’s balance sheet, which expanded significantly during the pandemic but has been shrinking since 2022 as part of quantitative tightening. This reduction in liquidity has contributed to higher yields on government bonds. Additionally, banking sector conditions can influence liquidity. If banks face funding pressures, they may reduce lending, leading to tighter financial conditions and higher interest rates. If liquidity remains constrained, the Treasury might adjust the fixed rate upward.

Hypothetical Rate Calculations

Estimating the next fixed rate for I Bonds requires examining recent trends in government borrowing costs, investor sentiment, and broader monetary policy shifts. The fixed rate is typically set at a level that ensures I Bonds remain attractive compared to other low-risk savings options while aligning with the Treasury’s broader debt management strategy.

Looking at recent Treasury securities issued with comparable risk profiles, such as the 10-year and 5-year Treasury notes, an upward adjustment in the fixed rate seems likely. If the 10-year Treasury yield remains in the 4.2% to 4.6% range, historical patterns suggest the fixed rate could land between 1.0% and 1.4%. This would continue the trend seen in late 2023 when the fixed rate rose above 1% for the first time in years. Given the Federal Reserve’s stance on maintaining higher interest rates to combat inflation, bond yields are unlikely to decline sharply in the near term.

Another factor influencing the fixed rate is how I Bonds compare to alternative safe investments, such as high-yield savings accounts and certificates of deposit (CDs). With some online banks offering savings rates above 4.5% and 1-year CDs exceeding 5%, I Bonds need to offer a competitive long-term return. If the Treasury aims to maintain investor interest, a fixed rate closer to 1.2% or higher could be justified, particularly if demand for I Bonds has softened compared to their peak in 2022.