Floating Rates.... Why?

Posted on May 1, 2012 by dlaidlaw

On May 2nd, the US treasury may detail plans for issuing floating rate bonds.  The floaters will most likely have maturities of 1 to 3 years with coupons that reset periodically based on a short-term benchmark, e.g. the federal funds effective rate.  The reason behind potentially issuing the bonds is to lessen the Treasuries reliance on Treasury Bills (Treasuries with less than 1 year maturity), which have to be rolled over frequently.  Issuing floating rate bonds will allow the government to borrow at low rates without having to auction securities as often as it does now. 

At first glance, continuing access to low rates makes sense.  But why not continue that access by issuing debt at various maturities for record low rates?  Selling floaters offers lower rates in the short-term, but rates will increase at some point.  So instead of locking in record low rates, the taxpayer will be on the hook when rates increase.  It makes sense to issue floaters when rates are high to take advantage of future declines, not when rates are at record lows.

The Treasury may feel demand is softening for short-term debt and get wary of having to roll over so frequently.  The Treasury doesn’t want to be stuck rolling over debt only to discover that the market is demanding higher rates, so perhaps this is a pre-emptive move.

While issuing floaters does not seem like a good move for the US taxpayer, it is good for the US investor.  As we’ve stated in the past, the Fed’s policy of low rates is punishing savers.  Floaters would be a good complement to TIPS as they would provide a hedge against rising rates.