With interest rate risk on the minds of many investors so far in 2014, we believe that floating rate Treasury securities represent an effective way for investors to help reduce their exposure to rising interest rates, while generating income payments that are backed by the full faith and credit of the U.S. government. Whereas other investments may also pay a rate of interest that resets each month or quarter, those securities are exposed to credit risk or the risk that the borrower will not be able to meet its financial obligations.
The Treasury decided to offer this floating rate option as an alternative to rolling three-month Treasury bills every quarter. This can help investors by reducing transaction costs and extends the holding period of their investments but not their interest rate sensitivity, which will hinge on the frequency of the reset (effective maturity of one week). As the market matures, floating rate note issuance is expected to be expanded to include notes with different terms to maturity.3 From an operational perspective, floating rate Treasuries can be an important addition to the investment opportunity set available to today’s investor.
1Source: U.S. Department of the Treasury, 1/29/14.
2Source: Barclays, as of 12/31/13.
3Source: J.P. Morgan.
Important Risks Related to this Article
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.
There are risks associated with investing, including possible loss of principal. Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but they may decline in value. The issuance of floating rate notes by the U.S. Treasury is new and the supply will be limited. Fixed income securities will normally decline in value as interest rates rise.