The U.S. Treasury recently made headlines when it auctioned off the first floating rate Treasury bond in its history.1 This was also the first new class of issuance by the Treasury since it issued Treasury Inflation-Protected Securities (TIPS) in 1997. As another means for the Treasury to fulfill growing investor demand and diversify its sources of funding, we believe that issuance and investor adoption of floating rate Treasuries are poised to increase over the next several years. By comparison, the last new product issued by the Treasury has grown to become a $750 billion market since 1997.2
Bond Basics: What Is a Floating Rate Treasury Note?
For many investors, exposure to bonds generally starts and stops with fixed income securities, which customarily pay a fixed rate of interest and refund the principal balance at maturity. However, floating rate notes are slightly different. Although floating rate Treasuries make payments to holders each quarter, the size of these payments is based on a rate that is reset daily in reference to a rate that is determined weekly. This reference rate is based on the high yield determined at the weekly 13-week Treasury bill auction, which is generally held every Monday.
Therefore, if yields on the Treasury bill auction rise week to week, investors could receive greater compensation than with a fixed coupon payment from a traditional fixed income investment. This reset frequency should also mitigate price fluctuations in floating rate notes compared to fixed income bonds of similar maturities. Given that these securities are issued by the U.S. government, they could serve as reference benchmarks for a variety of floating rate issuers in the same way that U.S. Treasury bonds serve as interest rate benchmarks for all other U.S. dollar-denominated fixed income issuance.
But there is never a free lunch in financial markets. At today’s levels, investors will likely receive lower coupon payments than with fixed coupon bonds of a similar maturity. However, in the current market environment, we believe that the opportunity cost of protecting against higher rates is low and the margin for error in navigating a rising rate environment is continuing to narrow.
What Role Can Floating Rate Treasuries Play in Investor Portfolios?