For bond investors who are interested in variable-rate investments that increase interest payments as general interest rates rise, things should be getting a lot more interesting in the next few months. The U.S. Treasury is scheduled to announce this month (November) the size of its initial January 2014 offering of new Floating-Rate Notes (FRNs).
According to the Federal Register, the Treasury will be able to issue FRNs with maturities between one year and ten years. The interest rate on these notes would effectively reset weekly based on the results from the weekly auction of 13-week Treasury bills. The actual interest rates would be equal to the 13-week T-bill rate plus some “spread” amount. Interest would accrue daily and be payable quarterly. The Treasury is expected to issue no more than four FRNs per year.
The initial January offering is expected to consist of $10-$15 billion of notes with 2-year maturities. One of the key advantages of these notes is that they will have a minimum net yield of 0%. This means that even if the Treasury allows T-bill auctions to result in negative interest rates, these notes will never be priced to reflect negative interest rates. Individuals may purchase these notes through Treasury Direct with a $100 minimum.
I am expecting these notes to be very popular, especially if interest rates drift higher. Banks (including foreign central banks) and corporate cash investors will be the dominant buyers, but individuals seeking a safe alternative to commercial floating-rate notes will also be buying. Holding these notes will be a popular alternative to rolling T-bills, which may incur significant transaction costs. The high demand for these notes will likely lead to relatively low yields (probably just slightly higher than the T-bills). Like other safe, but lower-yielding products, these notes will be excellent vehicles in which to park cash or to use to ensure preservation of capital in a rising-rate environment. Unfortunately, at least initially, the rates will still be too low to be attractive to most income investors. When interest rates are a little higher, and the Treasury offers longer maturity floating-rate securities, those will most certainly be smart investments for income.