17 July 2019

U.S. Treasury’s Introduction of Floating-Rate Notes Receives Warm Welcome

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Last November, the U.S. government announced plans to sell a new type of debt that would pay more interest as market rates rise. The $15 billion sale of so-called floating rate notes, which took place on January 29th, marked its first introduction of a new product since that of Treasury notes that protect buyers against inflation in 1997. 

The initial sale of these securities took place through an auction in which investors bid for 5.67 times the amount of debt on offer. The robust demand showed that investors are eager to protect their fixed-income investments amid expectations that rates will climb as the Federal Reserve pulls back its stimulus and after Treasury-bond yields have risen from historic lows over the past year. When bond yields rise, their prices fall.

The sale is the latest sign that the U.S., with $11.6 trillion in marketable government debt outstanding, is seeking to expand its borrowing options. In recent years the government has been seeking to extend the length of its average debt maturity by selling more longer-term bonds, a shift that locks in financing for a longer period but costs more relative to near-zero short-term rates. In February 2011, a group of investors that advises the government on market trends suggested the Treasury consider issuing floating-rate notes. Since then the Treasury has been working out details.

Investors already have been buying up nongovernment assets with floating interest rates over the past year. There are an estimated $300 billion in outstanding issues with varying interest rates. Among regular issuers of such securities are the government-backed mortgage companies Fannie Mae and Freddie Mac. Governments such as the U.K. and Italy long have issued floating-rate debt.

"There's no doubt the auction went well," said Peter Yi, portfolio manager at Northern Trust Corp. who oversees $240 billion of assets. The auction "exhibited a lot of confidence in the U.S. Treasury," he said.

The Treasury said in a release before the January sale that it expects to auction additional new floating-rate securities quarterly in April, July and October with two sales of notes with existing maturities in the subsequent months of each quarter. Floating-rate notes "bring additional diversity to Treasury's current portfolio and help support our goal of saving taxpayer dollars by financing the government's borrowing needs at the lowest cost over time," said Under Secretary for Domestic Finance Mary J. Miller in the news release.

Traders and analysts also predicted that demand would pick up speed in coming months as the Treasury sells more such debt and the market will become more liquid over time.

"Demand will continue to be high for floating-rate notes in a rising yield environment," said Bridget Daugsiewicz, a money-market fund manager at Manulife Asset Management in Boston. "The first sale is a good sign. For money funds that invest in U.S. government debt, this is a good way to diversify their holdings."

"As secondary liquidity is proven and valuations become more attractive, for liquidity minded strategies seeking same-day liquidity, Treasury [floating-rate notes] will become a pillar of liquidity management,'' said Jerome Schneider, head of the short-term and funding desk at Pacific Investment Management Co. in Newport Beach, California, which has about $2 trillion under management.

Click here and here for the original articles in the Wall Street Journal.

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