2-year floating rate notes auction
In January 2014, the US Treasury introduced the 2-year floating rate note (or FRN), which is a debt security with a variable interest payment. The reference for its rate is a benchmark like the LIBOR (London Interbank Offered Rate) or the 3-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.
- $15 billion worth of FRNs were auctioned—$2 billion higher than in March.
- The bid-to-cover ratio tanked to 3.81x—the lowest since January 2015—compared with 4.34x at March’s auction.
- The high margin rate came in at 0.07%—marginally lower than 0.09% in the previous auction.
- Direct bidders received only a minuscule portion of the auction. This follows from March, when they had not received any allocation.
Market demand fell to 63.1% of the accepted competitive bids, compared with 75.5% at March’s auction. The auction quantum was largely divided between indirect bidders and primary market dealers.
Indirect bids include bids made by foreign central banks and indicate overseas demand. They made up 62.7% of the auction, compared with 75.5% a month ago, which was the highest-ever allocation to the category. Direct bids include bids from domestic money managers like State Street (STT) and American International Group (AIG). They received only 0.42% of the auction, following no allotments in March.
Due to the fall in market demand, primary dealer takedown was up to 36.9%—compared with 24.5% at March’s auction. Dealers act as market makers and make up any shortfall in demand for the auctioned securities. Primary dealers include Citigroup (C) and J.P. Morgan (JPM), which are components of the S&P 500 Index (SPY).
Overseas demand for the 2-year floating rate notes remained high ahead of the Federal Reserve’s announcement of its stance on monetary policy on April 29. Floaters see their interest rate payments rising in an interest rate environment that is moving up. This is in contrast to regular Treasuries, which may decrease in value. An increase in rates would affect the overall bond market, including Treasuries (TLT) (IEF) and corporate bonds (JNK).
Exchange-traded funds (or ETFs) like the iShares Floating Rate Bond ETF (FLOT) allow investors to gain exposure to FRNs.