The U.S. Treasury is getting ready to issue floating-rate notes in late January 2014. I plan to sit this auction out despite my rule of thumb of investing when the U.S. Treasury issues a new type of security.
I instituted the rule based on the regret of not buying the first Treasury Inflation-Protected Security -- a 10-year note issued in January 1997, which is also the last time the Treasury issued a new security.
The coupon rate on that 10-year TIPS was 3.375 percent and the bonds were priced to yield 3.449 percent to retail investors. Basically, the Treasury was paying investors inflation plus 3.449 percent. I should have backed up the truck and loaded up on these securities. The new five- and 35-year TIPS maturities issued subsequent to the initial 10-year TIPS were also pound-the-table, back-up-the-truck issues. (The first 20-year maturity wasn't issued until 2004.)
Why am I breaking my rule of thumb? While floating-rate notes are attractive in a rising-yield environment, it's not short-term rates that are rising. In fact, the expectation is that short-term rates will stay low for the next one to three years, depending on which Federal Reserve watcher you follow, and the new floating-rate note is a two-year maturity with an interest rate that floats with the weekly auction yield on the 13-week Treasury bill. At this writing, the most recent auction of the 13-week bill had it yielding 0.065 percent.
For savers, the yield on a floating- or variable-rate CD would need to offer a higher yield than the Treasury floating-rate note for it to be attractive. If the CD is priced off the 13-week Treasury bill, the depositor would want a spread added to the Treasury yield. Just to be clear, I'm not talking about equity-indexed CDs or leveraged CDs here, just a plain vanilla variable-rate CDs.
An alternative to a floating-rate CD is a step-up CD, where the depositor can make one or more elections during the CD term to increase the yield on the CD without extending the term of the CD. These CD yields should be more attractive than floating-rate notes for the investor with a time horizon of one to three years.
Are you ready to invest in floating-rate notes?