In a December blog post, I compared Treasuries to step-up CDs and to floating rate notes. Now that the U.S. Treasury has auctioned its first-ever floating rate note issue, which is also the first new Treasury security offering in 17 years, I thought it would be a good time to take a look at the actual issuance.
The auction itself was wildly successful. The bid-to-cover ratio, a measure of the auction strength, was a strong 5.67 times the roughly $15 billion dollars of the two-year notes offered. Just because it’s popular doesn’t mean that it’s right for your portfolio.
Investors have been worried about rising interest rates. No one wants to be “long and wrong,” where the investor locks into a long-term fixed-yield security only to see rising yields — and falling bond prices. Floating rate notes help alleviate that concern by having the yield increase, along with rising interest rates.
The new Treasury issue, however, has only a two-year final maturity. The issue pays 0.045 percent over the yield on the three-month Treasury bill. The initial yield is 0.045 percent over the yield of the three-month Treasury bill auctioned on Monday, Jan. 27 with a yield of 0.055 percent. That means that until the next reset, the floating rate note will yield 0.10 percent.
Personally, I’d rather be “long and wrong” earning 0.34 percent, which is what the fixed-rate two-year Treasury note is yielding; or better yet, in a high-yield savings account earning 1 percent annual percentage yield, or APY, which can float with market rates; or even a two-year CD earning 1.15 percent.
As I pointed out in the earlier post, 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 final maturity with an interest rate that floats with the weekly auction yield on the 13-week Treasury bill.
The Federal Reserve Board meets roughly every six weeks. If we use what it did in the last two meetings to bootstrap a forecast to the end of its scheduled purchases of U.S. Treasury and mortgage-backed securities, it’ll take six to seven meetings to end the purchase program. That would mean either the late October or mid-December meeting until the program ends. Admittedly, we have a new interest rate sheriff in town, Janet Yellen, which may change how quickly the Fed is willing to end this quantitative easing program. But, if we assume that the end of quantitative easing comes before any increase in the targeted federal funds rate, which is a fundamental driver of short-term interest rates, the floating rate note will be celebrating its first birthday, or half its natural born days, before there’s any real upward pressure on short-term interest rates.
I say, “Don’t pick up any wooden floaters.” What do you say? How are you managing your investments given your outlook on interest rates?
Reach Dr. Don on Twitter: @drdonsays.