By Kevin Flanagan, Head of Fixed Income Strategy
Key Takeaways
- With the 3-Month/10-Year Treasury yield curve inverted, Treasury floating rate notes (FRNs), which are referenced to the weekly 3-Month t-bill auction, offer investors an income advantage without taking on excessive duration risk.
- The WisdomTree Floating Rate Treasury Fund (USFR) has outperformed the aggregate bond benchmark year-to-date, delivering income with significantly lower volatility compared to the broader bond market.
- As interest rates return to more historically normal levels, USFR provides a strategic tool for managing duration risk in fixed income portfolios, even in a potential “higher for longer” rate environment.
With the U.S. interest rate landscape returning to a more historically normal setting over the last year or so, investors are now presented with a backdrop that hasn’t been witnessed in literally more than a decade. As a result, I believe the bond portfolio decision-making process could benefit from taking an active/passive approach from a solution standpoint. In my blog post last week, I highlighted an active core strategy for fixed income investors to consider. This week, I wanted to feature a more passive income solution that comes without the volatility investors have witnessed in the broader bond market over the last couple of years.
In my opinion, Treasury floating rate notes (FRNs) offer bond investors an approach that can be combined, or “barbelled,” with other fixed income solutions when building a portfolio. Treasury FRNs are backed by the full faith and credit of the U.S. government and are reset with the weekly UST 3-Month t-bill auction and an accompanying spread. The WisdomTree Floating Rate Treasury Fund (USFR) allows investors to invest in this asset class in a user-friendly ETF structure.
Why should investors consider Treasury FRNs (USFR)?
- Looking at figure 1, the 3-Month/10-Year Treasury yield curve is still inverted so investors can attain an income advantage without taking on duration risk
- Fed rate cut expectations have been dialed back considerably, so this yield curve advantage should remain in place for the 2025 outlook, as well
- Even if the Fed cuts rates more than currently expected, the UST 3-Month/10-Year spread would have to steepen considerably from present levels before it would return to just neutral territory
Figure 1: Treasury 3-Month/10-Year Yield Curve
Figure 2: Year-to-Date Returns for USFR vs. its Benchmark
- Even with the Fed cutting rates, USFR has outperformed its benchmark, the Bloomberg U.S. Aggregate Bond Index (Agg), year-to-date
- USFR offers investors a solution that considerably mitigates the volatility that has been associated with the broader bond market in the post-Covid era
- A return to a normal Fed interest rate cycle positions USFR as a key component to managing duration risk in a bond portfolio
Conclusion
As I mentioned in the opening, interest rates have now returned to a more normal historical setting. And, even with rate cuts, investors could still be presented with what is viewed as a “higher for longer” regime compared to what many market participants had been accustomed to during the 2010–2021 period.
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This article originally appeared on WisdomTree’s website and is reprinted on VettaFi | ETF Trends with permission from the author. For more information, please visit WisdomTree.com.
Important Risks Related to this Article
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