U.S. Treasury will offer floating-rate notes

It’s big news when the U.S. Treasury rolls out a new product, since the last new one was Treasury Inflation-Protected Securities in 1997. That one worked out well, for both the Treasury and investors.

These floating rate notes will be of interest to TIPS buyers, I think, because they similarly ease the risk that buy-and-hold investors face with traditional Treasuries. We don’t know many details yet, and the floating rate notes won’t launch for about a year.

The Wall Street Journal says:

… the payments on these new notes would periodically reset to match prevailing market rates, as measured by a market index. The private-sector advisory committee that offers guidance to the Treasury suggested that the notes initially have a maturity of as long as two years.

TIPS pay a base return (lately that is 0.125% for most maturities), plus the principal is adjusted to reflect the overall Consumer Price Index. In reality, though, many TIPS after auction currently pay a negative yield to maturity, plus inflation.

These floating rate notes would react to prevailing interest rates, not inflation. So they could serve as a hedge against rising interest rates, which could harm the value of TIPS.

If they really are issued for two years, they would look make a good buy-and-hold investment today, when interest rates are ultra low. This assumes that the Treasury won’t allow the interest rate to go negative. At the moment, a two-year Treasury is paying 0.24%. I’d guess a floating-rate note would pay less, possibly close to zero interest with the chance of rising interest rates later.

Of course, interest rates could also go down, but if the Treasury didn’t allow a negative rate, that would make a floating-rate Treasury much more attractive than a traditional two-year Treasury.

The floating-rate note would also be a great alternative for investors who continuously turn over short-term Treasuries. The three-month Treasury is now paying 0.09%, practically zero. From the Wall Street Journal:

For buyers of Treasurys looking for a haven rather than an investment, floating-rate notes also might be relatively attractive. These notes will likely pay a higher yield than fixed bills, because investors will lock their money up for a longer period. And because yields on floating-rate notes reset automatically to mirror market rates, they wouldn’t have to be continuously redeemed and repurchased like short-term bills, a process that adds costs.

We won’t be able to buy these for at least a year, and so for now we can only speculate. My thinking is that if they are indeed 2-year issues and come with a guarantee of no negative interest rates, they will be worth considering in this ultra-low rate environment.

More on negative rates from Bloomberg. This was in Bloomberg’s report on the floating-rate Treasuries, but it wasn’t specifically referring to the floating-rate notes. TIPS buyers already know all about negative rates, because after-auction yields on many TIPS have been negative for more than a year:

The Treasury also said it is “in the process of building the operational capabilities to allow for negative-rate bidding in Treasury bill auctions, should we make the determination to allow such bidding in the future.”

Investors who bid at auctions for Treasury bills at negative yields would pay more than face value for the securities, ensuring that if they hold the debt to maturity they will get back less than they paid.

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2 Responses to U.S. Treasury will offer floating-rate notes

  1. I’m still torn in whether this is a good thing or not. Right now, I think it’s safe to say that there’s a good and bad to this scenario. As an investor, we’ll just have to weight the consequences.

  2. tipswatch says:

    Yes, there is a good and bad, but with Treasuries the difference tends to be slim, unless you are buying something like a long-term Treasury ETF, like TLT, which can be very volatile. If you bought a two-year floating rate Treasury, I’d say the risk and the upside would be about the same as a two-year Treasury. If you hold to maturity, you aren’t going to make much and you aren’t going to lose much. The main risk would be: Is you money better invested elsewhere?

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