The government is officially asleep at the EE Savings Bond wheel.
Although the government has set the short-term interest rate of EE Savings Bonds at just 0.6% it has not altered the original term (the time needed for the bond to double in price). That's still set at 20 years and if held that long the bond will yield 3.53% per year.
2^(1/20) = 1.0353
Click to enlarge.
The chart above compares the EE Savings Bond rate if held to original term (the time needed for the bond to double in price) to the rate of a treasury bond with the same duration (using interpolation on the treasury yield curve where needed).
Click to enlarge.
The chart above shows the rate markdown of the EE Savings Bond compared to a treasury bond of the same duration. That tends to be about 30%. Put another way, if the treasury bond yields 10% then the savings bond tends to yield about 7%. If the treasury bond yields 5% then the savings bond tends to yield about 3.5%.
The lower rate is due to the tax advantages that EE Savings Bonds offer (deferral of taxation, tax benefits for education).
As of today, the EE Savings Bond has an original term of 20 years. It therefore yields 3.53%. A 20-year treasury bond currently only yields 2.77%. As seen in the second chart, the mispricing between the two is currently at an extreme. What was once a premium to own EE Savings Bonds is now a discount.
So what does this mean?
In theory, if trading fees and taxes were absent then one could make risk-free money for 20 years by shorting $5,000 in 20-year treasury bonds while simultaneously buying $5,000 in EE Savings Bonds. The government would basically be paying you each and and every year for the next 20 years to do the trade (much like what it is doing for our biggest banks).
Or alternatively, I can't say that EE Savings Bonds are a good value to other things one could invest in, but it is clear that they are a good value relative to treasury bonds in general. Since I am generally a fan of relative value, that means I will probably be a buyer of EE Savings Bonds in 2012. That will make the 3rd year in a row. Go figure.
EE Savings bond rates and terms will not be changed again until May 1, 2012. There's no hurry to make the purchase though. In fact, it would probably be best to wait until April to make the decision. If the mispricing is gone in April it would only mean that interest rates on 20-year treasury bonds have risen dramatically. Who knows? It could happen.
Something will eventually fix this mispricing. That's about all I am sure of. I expected at least some of it to be fixed on November 1, 2011.
October 20, 2011
EE Savings Bond Rate Prediction for November 1, 2011
The government doesn't just set the interest rate. It also has the power to change the time it takes for a given EE savings bond to double in price. Since interest rates have fallen substantially, the odds of a duration change (for new purchases) are increasing substantially.
It would not surprise me to see the original term increase to 22-25 years at some point (perhaps very soon).
Treasury Direct: EE/E Bonds Rates & Terms
U.S. Treasury: Daily Yield Curve
St. Louis Fed: 5-Year Treasury
St. Louis Fed: 7-Year Treasury
St. Louis Fed: 10-Year Treasury
St. Louis Fed: 20-Year Treasury
St. Louis Fed: 30-Year Treasury
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