Two-year floating rate notes auction
The U.S. Department of the Treasury introduced two-year floating rate notes, or FRNs, in January 2014. A FRN is a debt security. Its interest payment varies. The reference for its rate is a 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 near zero interest rate risk.
- $13 billion worth of FRNs were auctioned. This was the same as in February.
- The bid-to-cover ratio rose to 4.34x—compared to 4.28x at February’s auction. It was the highest since September 2014. It’s closing in on the 4.4x average in 2014.
- The high margin rate came in at 0.09%. It was marginally higher than 0.08% in the previous auction.
- Direct bids didn’t see any allocation. The auction’s total increase was split between indirect bidders and primary dealers.
Market demand jumped to 75.5%—compared to 50.1% at February’s auction. The auction quantum was divided between indirect bidders and primary market dealers. Direct bidders didn’t get any allotment.
Indirect bids include bids made by foreign central banks. They indicate overseas demand. They made up 75.5% of the auction. This was the highest ever. They made up 48.2% a month ago. Direct bids include bids from domestic money managers like State Street (STT) and AIG (AIG). They didn’t get any allotment.
Due to the surge in market demand, primary dealer takedown was down to 24.5%—compared to 49.9% at February’s auction. Dealers act as market makers. They make up any shortfall in demand for the auctioned securities. They include the S&P 500 Index (SPY) components—Citigroup (C) and JPMorgan Chase (JPM).
Why did demand fall?
Overseas demand for the two-year FRNs surged on the hope that the Fed is closing-in on raising the short-term interest rate. Floaters see their interest rate payments rising in an interest rate environment that’s moving up. This is in contrast to regular Treasuries. They could decrease in value. An increase in rates would affect the overall bond market—including Treasuries (TLT) (IEF) and corporate bonds (JNK).
ETFs—like the iShares Floating Rate Bond ETF (FLOT)—provide exposure to FRNs.
In the next part of this series, we’ll look at US economic growth for 4Q14.