If investors suddenly demand a greater premium for holding U. So, issuing FRNs could help minimize the U. How will they be structured? The T-bill index is deep, stable, easily understood and has a long history, making it appealing to the Treasury. Additionally, if FRNs become a large component of future Treasury issuance, then T-bill issuance may be cannibalized. Interest will accrue daily and be paid quarterly. The rate will reset each week according to the result of the most recent week T-bill auction 0. This minimum is a critical characteristic that should increase FRN appeal in the event the Treasury allows for T-bills to auction at negative rates.
Although many details have been released, the Treasury has yet to specify the frequency and size of the auctions. Using this schedule, the Treasury will issue no more than four FRNs per year, which will ensure individual issues are larger and have greater secondary liquidity. Lastly, we anticipate that Treasury FRNs will initially replace some T-bill issuance but may eventually become a substitute for some fixed-rate coupon issues in the future as the Treasury looks to issue longer-dated FRNs.
Who will buy them? Investors who expect unconventional monetary policy to lead to an increase in rates would have an incentive to purchase FRNs as a hedge.
However, demand within channels may differ. Foreign central banks may be natural buyers for FRNs.
They currently hold about 25 percent of the T-bill supply and 40 percent of the Treasury coupon supply. Rolling T-bill holdings is a core strategy for these risk-adverse investors.
So holding FRNs, which minimize roll-related transaction costs, may be appealing. Corporate cash investors may also find them attractive.
Unlike money market funds, which are limited by a day weighted average maturity WAM calculation, FRNs offer corporate cash investors a similar duration as T-bills but with a potentially higher yield. Banks may be slow to adopt FRNs because currently they may deposit excess reserves with the Federal Reserve and earn 0.
However, they may find FRNs attractive in the future if the rates on these issues exceed the interest paid on excess reserves. Additionally, as regulators continue to pressure banks to increase the credit quality of their portfolios, FRNs may be particularly appealing given the increasing scarcity of high-quality assets. Total return TR managers, who often manage against a benchmark like the Barclays U.
Aggregate BAGG index, may have only modest demand for this security as well. However, some TR managers may purchase FRNs in order to post these securities as collateral for centrally cleared derivatives; this may be a growing source of demand for FRNs in the years ahead.
T-bills, so it might be a natural source of demand for short maturity FRNs. However, money market managers will need to weigh the benefits of holding an FRN rather than owning a slightly lower yielding T-bill with a fixed rate. One important consideration for a money fund manager is maintaining a portfolio that has a dollar-weighted average life WAL that does not exceed days.
Allocating a modest 5 percent of a portfolio to a two-year FRN will add a significant Will Pacific Investment Management Co.
Barclays says it "expect[s] discount perps to outperform corresponding fixed or fixed-to-float coupon hybrids if rates rise in the near to medium term," meaning prices would increase by 1. In the event of a bigger rates sell-off, the relative outperformance of discount perps is likely to be even more substantial — should the U.
Is this really advisable at a time when unprecedented monetary stimulus may lead to rising rates and inflation? The best time to buy floating-rate bonds is when rates are low, or have fallen quickly in a short period, and are expected to rise. Treasury product rises with the length of time until maturity. Paul Reisz is an executive vice president in the Newport Beach office and a product manager covering the spectrum of money market, enhanced cash and income strategies. The option is bought by the investor if the bond is putable and thus the benefit to the investor is brought down in the form of lower yields and higher bond prices— a lower option price as a proportion of the Z-Spread justifies it to reduce the benefit to the investor look at the formula — a lower option price leads to a higher bond price and hence a lower yield. Additionally, as regulators continue to pressure banks to increase the credit quality of their portfolios, FRNs may be particularly appealing given the increasing scarcity of high-quality assets. It's quite difficult, but really learned a lot!
Naturally, in that scenario, fixed-coupon securities would see significant negative total returns. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at or visit www.
We've detected you are on Internet Explorer. For the best Barrons. Text size. Trading at a deep discount to par and with floating-rate coupons, discount perps have negative rates duration and therefore provide a positive-carry way to hedge U. In [a rising-rate] environment, we believe that discount perps could act as an effective product to manage the interest rate duration of fixed income portfolios while still earning positive carry.
Close Barclays Finds Rising-Rate Protection In Discount Perpetual Floaters Barclays takes us deep into the weeds of income investing today, finding decent protection against rising interest rates in discount perpetual floating-rate notes. Thank you This article has been sent to.