My Comment to the Treasury on Floating Rate Notes

As I noted here, the U.S. Treasury is considering the sale of floating rate notes (“FRNs”) to help meet its funding needs.  The Treasury recently requested comments from the public on this topic.  I submitted this comment:

One of the reasons given in support of issuing FRNs is that they could help the Treasury achieve one of its goals: to increase the average maturity of its marketable debt.

A longer average maturity would mean that the debt would not need to be refinanced as frequently and so there would be less rollover risk.

Rollover risk for fixed-rate debt includes both liquidity risk and interest rate risk, but rollover risk for floating-rate debt is only liquidity risk.  The interest rate risk for floaters is present at every reset date.

Increasing the average maturity with FRNs could create the impression that interest rate risk is being reduced when it is actually being increased.

If the Treasury decides to issue FRNs, it should consider whether it is appropriate to continue to use average maturity as an indicator of interest rate risk.  It might want to use a new measure of that risk, as discussed in my article:

http://seekingalpha.com/article/390161-treasury-floaters-muddy-the-waters

The comment period closed on April 18. All of the comments will be published on Regulations.gov after they are reviewed, which may take several weeks.

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2 Responses to My Comment to the Treasury on Floating Rate Notes

  1. Ashwani says:

    Interesting piece of info. Win, would you elaborate more on “Increasing the average maturity with FRNs could create the impression that interest rate risk is being reduced when it is actually being increased.”

    Like

    • Win Smith says:

      Ashwani,

      Thanks for your interest.

      The Treasury Borrowing Advisory Committee, which recommended that the Treasury consider issuing floaters, gave this example: suppose the Treasury would normally plan to sell a certain amount of 6-month bills as part of its offerings. Instead, the Treasury could sell FRNs that mature in two years, with a daily interest rate reset. The FRNs would be outstanding 18 months longer than the bills, and would result in a slightly longer weighted average maturity for the Treasury’s entire debt portfolio than with the bills.

      The average maturity indicates how long the Treasury’s funding is locked in. A longer average maturity suggests that an issuer is better protected against a rise in interest rates, assuming the debt is all fixed-rate. The exposure of sovereign issuers to interest rate risk has often been measured with average maturity.

      But with the proposed floaters, a 2-year maturity would offer no protection against increasing interest rates, since the interest rate would be recalculated every day (based on 3-month T-Bill yields + a spread in the example). What the 2-year maturity accomplishes is to delay the need to return to the market to refinance this bit of funding, which could help the market to continue to absorb Treasury debt (an issue of liquidity risk).

      So the average maturity might increase while interest rate risk also increases, opposite to what’s expected with fixed-rate debt.

      I argue in the Seeking Alpha article that average maturity is not a reliable guide to interest rate risk when floaters are significant part of the debt portfolio.

      Did this answer your question?

      Thanks,
      Win

      Like

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