The U.S. may begin selling floating-rate notes for the first time in the second half of the year to help sustain demand for Treasuries while funding record budget deficits, according to Wall Street bond dealers.
Issuance may total about $10 billion a month, based on forecasts from nine of the 21 primary dealers that act as counterparties for the Federal Reserve. The Treasury Borrowing Advisory Committee, the group of bond dealers and investors that meets quarterly with the Treasury to share insights on the debt market, unanimously endorsed the sales, according to minutes of the group’s meeting released Feb. 1. A Treasury official who briefed reporters on condition of not being named said the next day that a decision on floating-rate notes could be made as soon as May.
The notes, in what would be the Treasury’s first new security since it began offering inflation-linked debt in 1997, would likely appeal to investors concerned that the Fed’s pledge to keep the federal funds rate at a record low through 2014 and other stimulus measures will eventually lead to an acceleration of inflation. The Treasury has said it may sell the securities to minimize borrowing costs, improve liquidity and expand its investor base as it funds a $1.1 trillion shortfall this year.
“People are looking for a safe asset where they can park funds for a while,” said Larry Dyer, a U.S. interest-rate strategist with HSBC Holdings Plc’s HSBC Securities unit in New York, one of the primary dealers that are required to bid at Treasury debt auctions. “For the Treasury, it may accomplish the goal of lengthening its funding with less roll-over risk. It lowers the volatility for investors.”
Government-run agencies including Fannie Mae and Freddie Mac sell floating-rate notes.
Issuance of floating-rate notes would likely displace 5 percent of current Treasury bill issuance in the first year, and supplant 20 percent of current bill supply over time, Priya Misra, head of U.S. rates strategy in New York at primary dealer Bank of America Merrill Lynch, said in an interview yesterday.
The total amount of bills outstanding at the end of 2011 dropped to $1.52 trillion from $1.77 trillion at the end of 2010 as the government ended programs to bail out the nation’s banks amid the worst financial crisis since the Great Depression.
The rate of the three-month U.S. Treasury bill was unchanged today at 0.076 percent. While that’s just below the high for this year of 0.0813 percent set yesterday, it’s still down from the average of 3.17 percent for the last two decades.
Demand for the securities may also come from banks boosting holdings of the highest-quality assets to meet Basel III regulations set by the Bank for International Settlements in Basel, Switzerland, Misra said.
“We expect interest from a variety of investors although the demand could be lukewarm as long as the Fed stay in perm-hold mode,” George Goncalves, the New York-based head of interest-rate strategy at primary dealer Nomura Holdings Inc., wrote yesterday in an e-mail. “Investors will be more interested once hiking cycles come imminent.”
The offering of floating-rate notes would expand investment opportunities for risk-averse investors including money-market funds, according to a Fitch Ratings note released Feb. 7. Money market funds limited to investment in Treasuries would benefit the most from an increase in supply, the note said.
“It’s hard to see anybody jumping up and down to get them with rates so low,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee. “If you think rates are going to go up soon, floating-rate notes may be interesting to you.”
Money-market funds were created in 1970 to offer investors better returns than bank savings accounts while providing a higher degree of safety. The funds have delivered historically low returns since the Fed cut its target rate in December 2008 to a range of zero to 0.25 percent.
Taxable money-market funds paid an average seven-day compounded yield of 0.02 percent, unchanged during the month ending Jan. 31, according to IMoneyNet Inc., a research firm based in Westborough, Massachusetts.