Why the 2-year FRN auction was popular with investors


Nov. 26 2019, Updated 12:28 p.m. ET

Two-year floating rate notes auction held on September 24

The U.S. Treasury introduced two-year floating rate notes (or FRNs) in January. A FRN is a debt security. It’s interest payment varies. The interest rate usually references an interest rate benchmark—like Libor or the three-month Treasury yield. The security’s interest payments rise and fall depending on prevailing market rates. As a result, FRNs have low interest rate risk.

Part 4

Highlights of September’s FRNs auction

  • The auction was a reopening of July’s auction
  • $13 billion worth of FRNs were auctioned
  • The bid-to-cover ratio increased to 4.45x—compared to 4.38x at August’s auction. The ratio averaged 4.70x in 2014.
  • The high margin rate came in at 0.04%—the lowest since the auction started

Auction analysis

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Market demand was much higher—at 59% of competitive accepted bids—compared to ~49.8% at August’s auction. The ratio of indirect bids increased significantly to 54.4%—compared to 46.5% in August. Indirect bids include bids made by foreign central banks. They indicate overseas demand. Direct bids include bids from domestic money managers. They increased to 4.6% from 3.3%.

Due to the increase in market demand, primary dealer takedown was lower at ~41%—compared to 50% in August’s auction. Dealers act as market makers. They make up any short-fall in demand for the auctioned securities. They include the S&P 500 Index (SPY) components—Citigroup and JPMorgan.

Auction analysis

Fears of future rate increases caused higher market demand for FRNs. Due to overall economic improvements, the Fed is expected to raise the federal funds rate next year. This will be the first increase in over six years. An increase in the base rate would affect the overall bond market—including Treasuries (TLT) (IEF) and corporate bonds (JNK). FRNs have low interest rate risk. As a result, they will likely be popular among investors as the liftoff approaches.

Exchange-traded funds (or ETFs)—like the iShares Floating Rate Bond ETF (FLOT)—provide exposure to FRNs.

You can learn more about the two-year FRNs issued by the U.S. Treasury and how to invest in them in the Market Realist series, “Why investors should look at floating rate notes as an option.”

In the next part of the series, we’ll analyze the key trends in last week’s auction for seven-year Treasury notes.


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