The last time the U.S. Treasury introduced a new security, you
could buy a gallon of gas for $1.24, the Dow Jones industrial
average traded below 7000, and
was popular on TV. The year was 1997; the bonds, Treasury
Uncle Sam is about to do it again. Get ready for floating-rate
notes, expected in the fourth quarter of this year or early in
2014. Their interest rates will change over time, paying investors
more when market rates rise and less when they fall. Until now,
Treasury bonds and notes have always paid fixed rates (although the
principal value of TIPS adjusts with inflation).
All the details aren't out yet. As it stands now, the notes will
have a two-year maturity (with longer maturities perhaps coming
later) and will make quarterly interest payments. The interest rate
will be pegged to the yield on three-month Treasury bills and will
change weekly in accordance with the T-bill auction. The rate on
the notes would be the T-bill rate, currently 0.04%, plus a bit
more--0.05 to 0.10 percentage point, say, depending on demand when
the notes are auctioned.
The Treasury plans to auction the notes quarterly, and investors
will also be able to purchase them through the TreasuryDirect
program with a $100 minimum investment. Money market funds
scrambling to find enough high-quality, short-term assets to invest
in are expected to be big customers, as are banks.
The appeal of floating-rate securities to investors is
obvious--especially now, with rates at rock-bottom. With a
fixed-rate bond, when rates rise, the value of the bond falls
because newer bonds pay more. But when interest payments rise along
with market rates, the value of the security remains stable. "This
is a good deal for investors," says Jim Bianco, president of Bianco
Research. "The rate will adjust with market conditions, and since
market conditions are already at zero, it can only adjust one way.
If you buy short-term, high-quality debt like T-bills, this
provides a very good alternative."
The Treasury says it wants to attract more investors and lock in
longer-term funding in a cost-effective way. By subbing floaters
for a portion of its T-bill issuance, the government pays a little
more than it would on T-bills, but not much more--a trade-off it's
willing to make so that it doesn't have to depend on investors
rolling over T-bill holdings every three months.
The new floaters will find a niche, says investment strategist
Marilyn Cohen, of Envision Capital Management. "You're not going to
get rich, but it'll quell some fear about higher interest rates."
(Many investors concerned about higher rates resulting from
inflation are buying TIPS. But TIPS aren't immune from losses when
rates rise--especially if they rise faster than consumer prices
Critics say the deal for taxpayers is questionable. Better to
lock in historically low rates with the longest-dated bonds
possible. Think of a homeowner choosing between a fixed-rate
mortgage and an adjustable-rate loan, says Campbell Harvey, a
finance professor at Duke University. "If you go for the ARM,
you'll have to pay more if rates go up. Why would you do that when
you could lock in a fixed rate?"