This Bond Is A Loser For Investors

In January 2014, the U.S. governrnment began issuing Floating Rate Notes (FRNs). I was never a fan because the structure of the notes seems entirely one-sided. They call for investors to give the governrnment use of their money and provide almost no interest in returnrn.

While the notes have only been on the market for a couple of months, the combination of the structure of the securities and the Federal Reserve’s guidance confirms my view: This bond is a loser for investors!

The FRNs are two-year bonds that pay two types of interest — one fixed and one floating. When the bonds were issued, the fixed rate of interest was set at 0.045%. Note that this is not a typo. The fixed portion of interest on these bonds is less than one-tenth of one percent… per year!

In addition to the fixed interest, the bonds carry a floating interest rate component, which is pegged to the most recent 13-week U.S. Treasury bill rate. The last auction of 13-week Treasury bills put this rate at 0.03%.

Adding the two types of interest together, an investor will receive 0.075% on this two-year security. That equates to $75 on a $100,000 investment!

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Given that the Fed has declared short-term interest rates all but dead for at least another year, it’s hard to see why anyone would buy these bonds.

Is the extra 0.045%, or $45 on a $100,000 investment, worth locking up your money for two years? Wouldn’t it be simpler to just buy the two-year bond, which is yielding 0.375%? Picking up an extra 0.3%, or $300 per $100,000, is a 400% increase in returnrn.

The worst an investor could do is break his investment down into several components, buying some 13-week bills, some one-year notes and some two-year notes. Then, at least, he’d have a blend of interest rates.

Perhaps there is a good reason for buying these two-year FRNs, which essentially provide cost-free debt to the governrnment, but I don’t see it.

Of course, the entire argument against these securities and their 0.075% yield rests on the notion of earnrning up to a whopping 0.375% on two-year Treasury bonds. But then, neither investment makes any sense! With stated inflation running at 1.5%, either investment would lose purchasing power.

Unless you’re using Treasurys as a parking spot for idle cash, this is a part of the market that retail investors should avoid altogether.

Rodney

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