The bond market hardly needed another smoking gun, but it got one just the same today when news hit the streets that the government was taking away the floating interest rate on EE Savings Bonds.
No longer would the Treasury pay owners of EE Savings Bonds 90% of the average yields on five-year Treasury Notes. The forumula was fine when the price of money was falling, and so a variable interest-rate payout worked to the government’s advantage (and to the disadvantage of owners of savings bonds). But things have changed, don’t you know? Interest rates are moving higher. That is, unless you buy EE Savings Bonds as of May 1, a fixed-income security that promises investors that time will stand still when it comes to interest rates.
“The Treasury Department announced today that Series EE Savings Bonds issued on and after May 1, 2005, will earn fixed rates of interest,” reads the press release. “The new fixed rate will apply for the 30-year life of each bond….”
In a world where interest rates are rising, and arguably will continue rising, the government has decided that investors in savings bonds should have a fixed payout. Paying 90% of the five-year’s yield threatens to be a loosing proposition for the Treasury. Of course, considering that ours is a government suffering no shortage of red ink perhaps it’s unsurprising to learn that penny-pinching has become the policy bias of choice. “This is a huge change,” says Daniel Pederson, author of Savings Bonds: When to Hold, When to Fold and Everything In-Between. Speaking to AP via BusinessWeek, he explained that a “return to fixed rates would appear to be… a way for the government to save money and as an investor, if the government saves, that means you are getting less.”
Perhaps bond investors of all stripes should start getting used to getting less in terms of total returns. The benchmark 10-year Treasury Note’s yield has climbed sharply since early February, which means that capital losses are on the march as well. Presumably, the rising red ink on the fiscal and trade-balance fronts, along with the weak dollar and the fallout of several years of a negative real Fed funds rate, are starting to convince the fixed-income set that even tougher times may be coming to bondland.
The U.S. Treasury, to name one institution, is convinced of nothing less.