Last week, the Federal Reserve raised interest rates for the third time this year, prompting fixed income market participants to speculate a fourth rate hike will arrive in December and that the Fed will again raise rates multiple times next year.
Floating rate notes (FRNs) have been popular destinations this year for fixed income investors amid Fed tightening. One of the fastest-growing exchange traded funds this year in the FRN category is the WisdomTree Bloomberg Floating Rate Treasury Fund (NYSEArca: USFR). USFR, which debuted in February 2014, follows the Bloomberg U.S. Treasury Floating Rate Bond Index. The fund’s holdings are priced at a spread over 3-month Treasury bills. Floating rate notes featured in USFR mature in 2019 and 2020.
The current environment is conducive to FRN strategies.
“Against this backdrop, fixed income investors will more than likely continue to search for rate-hedging solutions. One approach investors tend to implement involves U.S. Treasury (UST) Inflation-Protected Securities, or TIPS,” said WisdomTree in a recent note.
A Low Risk Proposition
Looking ahead, the floating rate notes will generate more interest if Treasury prices fall and yields rise further, which should play out if the Fed continues on its interest rate normalization schedule.
TIPS are a type of Treasury security that are indexed to inflation as a way to shield investors from the negative effects of inflation. The securities’ par value rises with inflation as measured by the Consumer Price Index while interest rate remains fixed. TIPS also offer investors another layer of diversification as many aggregate bond funds exclude TIPS from their holdings.