As borrowing costs stay surprisingly low, the Treasury Department is looking smarter than the initial critics of its floating-rate notes program.
Demand for the securities has exceeded that for fixed-rate debt at U.S. government auctions since the Treasury first sold the notes in January 2014, even as interest rates remained low. A class of investors that includes foreign central banks and domestic asset managers bought a record 75.5 percent of the $13 billion two-year offering sold March 25.
Investors are flocking to the securities—which have interest payments reset higher as borrowing costs rise—as the Federal Reserve gets closer to raising rates for the first time since 2006. Critics have said the Treasury should be seeking to lock in historically low borrowing costs since the securities were introduced.
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"Floating-rate assets, as a category all together, are very attractive now," Scott Minerd, global chief investment officer at Guggenheim Partners LLC, which manages $220 billion in assets, said in a phone interview. "For investors that must be in government debt, a portfolio that barbells with Treasury floaters along with longer-duration securities will outperform."
Floating-rate debt, whose interest payments are linked to a short-term money market instrument, will see those payouts rise as the Fed begins lifting rates. Holders of fixed-coupon securities, which will see bond prices fall as market rates rise, will receive no offset from higher interest payouts.
The bid-to-cover ratio, which measures the number of bids to the amount of securities sold, has averaged 4.34 since the first offering in January 2014. During the same period, the bid-to-cover ratio is 2.85 for all fixed-rate Treasuries sold.
The notes are considered an alternative to Treasury bills because they are benchmarked to a short-term index—the high rate from a 13-week bill auction. The notes provide investors with a yield of over 8 basis points, or 0.08 percentage point, more than bills, adding to the allure, said Minerd.
"Floaters' demand is definitely there, especially ahead of the Fed's upcoming tightening cycle," said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., one of 22 primary dealers that are obligated to bid at the auctions. "People want floating-rate exposure ahead of higher rates that everyone is thinking and talking about. That speaks volumes that this product will continue to do well."
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