Back in May 2020 we first suggested that student loan borrowers could take advantage of a carry trade by investing their would-be loan payments in bonds yielding more than 0%. Several payment pause extensions later, we wanted to see how that trade worked out.
At that time we offered a few investment suggestions, but in retrospect missed a big opportunity: Treasury Series I Savings Bonds. These are bonds issued by the US Treasury that pay a fixed rate of interest for the life of the bond plus a variable inflation rate tied to the Consumer Price Index for all Urban Consumers (CPI-U) that changes twice per year. Through the end of 2021, bank loans and short-term corporate bonds produced positive returns while short-term Treasuries were a push. But at midyear 2022, due to the rapid shift in the Fed’s monetary policy resulting in higher rates, bank loans were the only fixed income asset that had eked out a positive total return between June 1, 2020 and June 30, 2022 (Figure 1).
Figure 1 – Comparison of Cumulative Returns
Source: Morningstar Direct
Treasury Direct I Bonds
But unlike two years ago, inflation is top of mind today. The Consumer Price Index reached 40-year highs of 9.1% in July 2022 compared to a scant 0.1% in May of 2020. Since that time, the once obscure Treasury Series I Savings Bonds have become all the rage. These bonds, issued by the US Treasury, pay interest that’s adjusted semi-annually for inflation. In 2020, the Treasury sold $29 million in I Bonds per month, while in the first half of 2022 monthly sales averaged a whopping $2.9 billion (Figure 2).
Figure 2 – Gross Sales of Treasury Series I Savings Bonds (1/1/20–6/30/22)
Source: Fiscal Data
Higher Inflation, Higher Return
Taking the 3-month redemption penalty into account, the cumulative return for an investment in an I Bond purchased June 1, 2020 would have been +5.5% through June 2020 and +6.7% through August 2022 when student loan payments are scheduled to restart. With the benefit of hindsight, we really missed an opportunity. But for those interested, I Bonds issued before November 2022 will earn 9.62% for the first six months before the CPI-indexed rate adjusts (Figure 3).
Figure 3 – I Bond Composite Interest Rate (0% fixed rate + CPI-U)
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