Treasury Receives Mixed Advice on Floating Rate Note Index

Feedback from participants and observers in the government bond market was split on what benchmark index the U.S. Treasury Department should use for pricing floating-rate notes, according to public comments.

The Treasury, which plans to issue floating rate notes later this year, queried feedback on Dec. 5 on the structure of the securities. The questions included one on whether the 13-week Treasury bill auction high rate or a Treasury general collateral overnight repurchase agreement rate would best “result in the Treasury attaining the lowest cost of financing over time.” The highest accepted competitive yield bid at a Treasury bill auction is also known as the stop-out, or stop, rate. The comment period ended yesterday.

The floating-rate notes would be the first new U.S. government debt security since Treasury Inflation-Protected Securities, known as TIPS, were introduced in 1997. With a budget deficit over $1 trillion last year, the Treasury needs to expand its base of investors, and floaters may appeal to those who are seeking to protect themselves from a possible increase in interest rates or faster inflation stemming from the Federal Reserve’s unprecedented monetary stimulus.

“In a hypothetical market stress scenario where perceived U.S. credit risks increased sharply, FRNs tied to bill yields offer little diversification benefit,” JPMorgan Chase & Co. said in a comment letter dated Jan. 16. “By contrast, repo rates are likely to be more stable in this circumstance, producing lower repricing risk for the Treasury. This has clearly been evident in recent years in Europe where peripheral bill yields have increased significantly more than repo rates as credit concerns escalated.”

GCF Index

The Depository Trust & Clearing Corp. publishes daily a GCF Repo index for Treasuries, which is a weighted average of all general collateral finance repurchase agreements between dealers each day through the tri-party market. The Treasury noted the index as an option for use as the repo benchmark in its request for public comment. The Treasury also sought feedback on the merits of using a broader measure, which currently doesn’t exist, of general collateral tri-party repo, given the DTCC index is a subset of the transaction among dealers only.

The federal funds effective rate, a volume-weighted average of trades between major brokers for overnight funds that is reported on a day lag by the Federal Reserve Bank of New York, would be the most ideal choice as a reference rate for Treasury floaters, wrote Troy Rohrbaugh, head of global rates and foreign exchange at JPMorgan, in the bank’s response.

‘Most Consistent’

The average rate for borrowing and lending Treasuries for one day in the repo market was 0.08 percent yesterday, according to the DTCC GCF Treasury Repo index. That rate has fallen from as high last year as 0.526 percent on Oct. 29. The fed effective rate was 0.14 percent yesterday.

“We believe that a Treasury bill index is most consistent with the Treasury’s objective to obtain diversified funding at the lowest possible cost,” Citigroup Inc. said in a letter dated Jan. 22 in response to the Treasury’s comment request. “Repo rates tend to be more volatile than T-bill rates measured at a daily frequency and can move dramatically higher or lower based on technical factors unrelated to demand for Treasury debt. The drawbacks of a repo index, particularly the questions surrounding the availability, consistency, and representativeness of the index, are more significant that those associated with a T-bill index.”

The rate on the current Treasury bill maturing on Feb. 14 is 0.04 percent, according to Bloomberg Bond Trader prices.

Borrowing Costs

The Treasury sought comment from the public on the design details, terms and conditions, and other features of a floating-rate note program. Floating-rate notes, which are already being offered by Fannie Mae, Freddie Mac and some European banks, have coupon payments linked to changes in short-term rates, which in the U.S. have been close to zero since late 2008.

The Treasury will use the floating-rate note program “to assist us in our mission of borrowing at the lowest cost over time, as well as to manage the maturity profile of our marketable debt outstanding, expand the investor base, and provide financing tools that gives debt managers additional flexibility,” according to the note published in the Dec. 5 Federal Register.

The Treasury has in recent years sought to lock in record low borrowing costs for longer terms and cut the amount of outstanding short-term bills, which ballooned to $2.1 trillion during the financial crisis that began almost five years ago.

“The 13-week Treasury bill rate should provide lower borrowing costs for the government versus a Treasury general collateral repurchase agreement rate,” according to a response dated Jan. 10 from Bank of Montreal’s BMO Capital Markets unit in Chicago, written by Scott Graham, head of government bond trading. “The 13-week bill rate has been less volatile than the overnight general collateral rate over the past 10 years. A funding vehicle that is less volatile should result in a lower funding cost.”

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