Should you buy CSBs this year?

The new issue Canada Savings Bonds (CSBs) and Canada Premium Bonds (CPBs) is now on sale and the interest rates have shocked everyone. I’ve said previously that safety is expensive right now, and this is a classic example.

At 1.8 per cent, the one-year rate on CSBs is the lowest ever. In fact, with the latest core CPI rate (August) at 2.3 per cent, the bonds produce a negative real return. Holding them in a taxable account will make that negative return even worse.

Why buy CSBs?
Why would anyone want to buy this issue of CSBs? Frankly, I can’t think of a single good reason. If you’re looking for a combination of safety and liquidity, regular one-year Canada bonds are yielding about 3 per cent right now.

You can currently receive 3.5 per cent by putting your money into an investment savings account at ING Direct. Money market funds are showing current yields in the 2.5 to 3.5 per cent range. So there are lots of better options.

Premium Bonds better
The Canada Premium Bonds (CPBs) offer a slightly better one-year rate, at 2.3 per cent. CPBs aren’t as liquid, as they can only be redeemed for a limited period eacyear at the anniversary date.

But what’s especially interesting here are the rates for the second and third years. CPBs offer a three-year guarantee whereas CSB rates change annually.

In year two (starting Nov. 1, 2002) the current issue of CPBs will pay 2.8 per cent. In year three (from Nov. 1, 2003) the rate rises to 4 per cent. The blended rate is just over 3 per cent for the three years.

Sends signal
That’s not particularly enticing in itself. Regular three-year Canada bonds are currently yielding in the 4 per cent range. But it appears to send an interesting signal about the expectations of the Department of Finance and the Bank of Canada for interest rates going forward.

Reading between the lines, these rates suggest that the financial braintrust in Ottawa anticipates a stabilization in the economy next year, with the decline in interest rates ending.

By mid to late 2003, they appear to be looking for a significant economic recovery, with short-term interest rates starting to rise again.

Stay short term
If this scenario is anywhere near the mark, it suggests being very careful about investing in long-term bonds or locking in five-year GICs at this time.

Unless we are to expect a flattening of the yield curve (not likely in the current situation), long-term rates will rise in step with short-term increases. That means the price of long-term bonds will decline, creating the risk of a capital loss. It would be a situation similar to that which we witnessed in the first half of 2000.

So stay short-term with your fixed-income securities for now. The yield may not be great, but the risk is small.

Check ’96-’98 bonds
While we’re on the subject, check to see if you own any CSB or CPB issues from 1996-98. Some of them are paying remarkably high rates by today’s standards.

For example, the CPB issues of March 1 and April 1, 1997 (series P1) carry an interest rate guarantee going all the way out to 2007. They’re currently paying 6.25 per cent and this rate steps up each year until it reaches 8.5 per cent in the final 12-month period.

The P2 series of 1998 is nowhere near as generous but does pay a rate of 4.35 per cent now, rising to 4.45 per cent next year and 4.55 per cent the year following.

Keep these bonds
CSB issue S51 (Nov. 1/96) is also very generous, with a guaranteed rate to 2005-06. It is currently paying 6.5 per cent, rising to 6.75 per cent on November 1 and escalating all the way to 8.75 per cent in the final year. Series S52 and S53 are also very good.

If you own any of these bonds, keep them. If they are in a non-registered account, put them into an RRSP to avoid paying tax on the high interest you’re receiving. You can do this very easily by setting up a no-fee Canada RRSP.

And, of course, you’ll be able to claim the value of the CSBs plus accrued interest as an RRSP deduction. For more information, visit the Canada Investment and Savings Web site at:

From the Oct. 15 edition of the Internet Wealth Builder newsletter.