Why did demand for floating-rate notes decline?

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Floating-rate notes

Floating-rate notes (FLRN) are the Treasury’s most recent issue. Their first auction was held in January 2014. They offer you a term-to-maturity of two years. A floating-rate note (FLOT) is a debt security with a variable interest payment. The interest rate usually references an interest rate benchmark—like LIBOR or the three-month Treasury yield. As interest rates rise, the security’s interest payments are expected to increase. So its yield increases. Conversely, FRN interest payments decrease as interest rates fall.

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The U.S. Treasury holds original-issue auctions for FRNs in January, April, July, and October, with reopenings scheduled each month in the remaining months. Reopenings are reissues of securities offered previously at the same coupon and maturity date, but with a different purchase price. The week ending June 27’s auction of FRNs was the second reopening of the auction held in April. So the FRNs auctioned for the week ended June 27 are slated to mature in a year and ten months—in April 2016.

 

The floating-rate note auction held on June 25

Bidding activity at June’s two-year FRN auction weakened. The bid-to-cover ratio declined from 4.69x in May to 4.43x at last month’s auction. The original April issue had generated a bid-to-cover ratio of 4.64x. The issue size remained the same for all three auctions, at $13 billion. The high discount margin for the auction came in at 0.069% in June. This was the same as in April, but higher than May’s 0.063%.

Demand-side factors

Dealer bids accounted for a higher share of competitive bids in June, at almost 55%, compared to ~49% in May. The share of both direct bidders and indirect bidders declined, showing weak underlying market demand for the issue.

Dealers are market makers. They make up any shortfall in demand for the auctioned securities. A lower percentage of accepted dealer bids shows you strong underlying market demand. Currently, there are 22 approved dealers, including financial intermediaries like Citigroup and JPMorgan. Both firms are part of the S&P 100 Index (OEF).

Bidding for the FRN auction was affected by the Fed’s reiteration of its monetary stimulus policies at the end of last month’s FOMC meeting. The policies will continue to keep interest rates low for some time. FRNs, by definition, pay a floating interest rate. So, compared to Treasury notes (SHV) and Treasury bonds (TLH), which are fixed-rate securities, investor interest fell due to the prospect of low rates in the near future.

To learn more about floating-rate notes, please read the Market Realist series Why investors should look at floating rate notes as an option.

In the next part of this series, we’ll analyze the key trends at auctions for Treasury bills. Please read on.

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