By Emily Flitter and Glenn Somerville
NEW YORK/WASHINGTON, March 19 The U.S. Treasury Department on Monday asked for public views on whether to sell floating-rate notes that would offer a new way for investors to protect themselves from interest rate risk while keeping their money in safe-haven U.S. debt.
Issuing "floaters," as they are called, would amount to the Treasury's largest new product launch since it began selling inflation-linked notes and bonds more than 10 years ago.
"There's definitely a market for it," said Joe Larizza, a Treasuries and agencies trader at Raymond James in Memphis.
"Most of the market would be money market funds, municipalities, short-term cash positions for hedge funds and other bond funds."
Floaters would not offer investors a fixed coupon but base coupon payments on a dynamic interest rate such as the benchmark, 3-month London Interbank Offered Rate, which changes daily based on big banks' reports of their borrowing costs.
This would be important, traders said, for investors who would normally buy a risk-free Treasury bond at a yield that was acceptable in a low interest-rate environment and then try to protect against being stuck with the low-yielding bond as rates rise in the marketplace.
The rate on the floater would rise alongside increasing rates in the marketplace, keeping pace with inflation and essentially maintaining the original value of the investment.
Larizza cautioned the floater would never be a hot, high-yielding vehicle. It would just not contain the risk of losing value as inflation picked up speed.
An October 2011 Citigroup analysis found domestic banks would be among the most likely buyers. Banks normally manage some of their cash using bond coupons and swaps, which combined are about as liquid as Treasury floaters would be.
"We think the Treasury can probably issue floating rate notes and create a new market segment," the Citi note said. "There is sufficient risk premium in term securities to make this a worthwhile exercise for them."
Floaters would also ease the burden money market funds have been under since the 2008 financial crisis. New regulations imposed after a large money fund "broke the buck" in September 2008 have restricted products they can buy. They now have to keep more cash in shorter-term vehicles.
Deborah Cunningham, executive vice president and chief investment officer at Federated Investors in Pittsburgh, said money funds would enthusiastically buy floaters.
After writing a slew of comment letters expressing deep concerns over proposed new regulations for money funds, Cunningham said she and her team were "diligently" working on a comment describing the benefits of Treasury floaters.
"It's definitely a different tone," she said, explaining that Treasury floaters would count as securities with very short maturities -- since their "maturity" date would be counted as the date on which their interest rate resets, not the date the actual security completely matures.
That would reduce the price volatility of the securities. A money fund could use the steadier prices to more easily maintain its net asset value of $1.
"To be able to do that in a Treasury fund would be hugely beneficial," she said.
The Treasury has been contemplating issuing floaters for several months. During the department's Feb. 1 quarterly refunding announcement, Assistant Treasury Secretary Mary Miller said official discussions were ongoing.
The Treasury Borrowing Advisory Committee's report ahead of the last refunding said floaters looked "extremely attractive" in the context of a decline in available high-quality global government bonds as well as rising demand for safe assets.
In a notice published in the Federal Register, the Treasury stressed it has not yet made a decision.
But it asked a series of detailed questions about how market participants thought such a note should be structured and set a deadline of April 18 to respond. The next Treasury quarterly refunding announcement is set for May 2.