Two-year floating rate notes auction
The U.S. Treasury introduced two-year floating rate notes, or FRNs, in January 2014. An FRN is a debt security. Its interest payment varies, hence the name. The reference for its rate is a benchmark-like LIBOR (London interbank offered rate) or the three-month Treasury yield. The security’s interest payments rise and fall depending on prevailing market rates. As a result, FRNs have near zero interest-rate risk.
- $13 billion worth of FRNs were auctioned—$2 billion less than in January.
- The bid-to-cover ratio jumped to 4.3x compared to 3.7x at January’s auction. It’s now closing in on the 4.4x average in 2014.
- The high margin rate came in at 0.08%—the same as at the previous auction.
Market demand fell to 50.1% compared to 54.0% at January’s auction. Meanwhile, indirect bids rose. They made up 48.2% of the auction as compared to 47.1% a month ago. Indirect bids include bids made by foreign central banks and indicate overseas demand.
Due to the lower market demand, primary dealer participation was higher, up to 49.9% over 46% at January’s auction. Dealers act as market makers. They make up any short-fall in demand for the auctioned securities. They include S&P 500 Index (SPY) components Citigroup (C) and JPMorgan (JPM).
Why did demand fall?
Demand for two-year floating rate notes fell on dwindling hope that the Federal Reserve will raise rates in mid-2015, as expected by several entities. These hopes were negatively affected after the release of the minutes of the Federal Reserve’s January meeting as well as the dovish stance taken by Janet Yellen during her congressional testimony.
Because FRNs have low interest rate risk, they’re favored when the Fed is about to raise rates. An increase in rates would affect the overall bond market, including Treasuries (TLT) (IEF) and corporate bonds (JNK).
ETFs such as the iShares Floating Rate Bond ETF (FLOT) provide exposure to FRNs.
In the next article, we’ll look at why US economic growth for the fourth quarter was revised down.