Treasury FRNs: Not Just a Rate Hedge

This year marks the 10-year anniversary of the issuance of U.S. Treasury (UST) floating rate notes (FRNs). Back in January 2014, the nation’s debt managers auctioned the first tranche of these new securities, and over the years, UST FRNs have grown to be an important part of the Treasury’s regular financing calendar. However, arguably more pertinent, they have become an integral aspect of investors’ fixed income portfolios. Typically, FRNs of any kind are viewed as being more of a tactical interest rate “play,” but in the case of Treasury floaters, investors are discovering that they also offer a strategic solution beyond being just a rate-hedging strategy.

There is no doubt that UST FRNs served as a formidable investment strategy to help navigate the Fed’s recent historic rate hike cycle and attendant surge in Treasury yields over the last two years. In fact, one could argue that at times during this rate increase period, it seemed as if investors had no place to hide but in UST FRNs, as a variety of different asset classes were in the negative column. 

For the most recent month-end and standardized performances and to download the respective Fund prospectuses, click here.

In order to take advantage of the opportunities Treasury FRNs could offer investors, we launched the WisdomTree Floating Rate Treasury Fund (USFR) back in early 2014 as well. In other words, USFR is also celebrating its 10-year anniversary this year. While investors quickly gravitated to the benefits of this strategy when the Fed was tightening monetary policy, it is becoming increasingly apparent that this approach is also a solution to consider from the current and prospective interest rate landscapes.

With the pivot from Fed rate hikes to the prospect of Fed rate cuts now apparently in full swing, investors have been getting a firsthand look at how Treasury FRNs have been performing versus the broader bond market. The “real” pivot occurred at the December FOMC meeting when Chairman Powell, as well as the dot plots, laid out the Fed’s thought process that three rate cuts were being projected for this year.

Over this two-month period, it has been interesting to see how USFR has performed compared to the benchmark Bloomberg U.S. Aggregate Total Return Index, better known as the Agg. As the above graph highlights, the Agg has experienced a rather large amount of volatility as optimistic expectations for the timing and magnitude of potential rate cuts have undergone a visible transformation. It’s not that rate cuts have been ruled out, but rather the Fed, along with the labor market and inflation data, has not validated the broader market’s early enthusiasm. In fact, the money and bond markets’ current rate cut expectations have gone from six to about four decreases, or closer to what the Fed is projecting. Meanwhile, USFR has experienced a steady ascending trend and, as of this writing, has produced a positive total return of just under +1.0% versus a decline of a little over -1.0% for the Agg.

Another important point to consider is the yield differential between the two, where the average yield to maturity for USFR is 5.49%, or about 60 basis points (bps) above the Agg. In addition, the duration profile is strikingly different, as USFR possesses a one-week duration while the Agg’s is 6.25 years. In other words, the Treasury FRN strategy is offering visibly more yield without the added duration and elevated volatility of the Agg.

And don’t forget the yield curve is still inverted; hence, UST floating rate notes (FRNs) are the highest-yielding Treasury security by a wide margin in many cases. So, even if the Fed cuts rates by 100 bps in 2024, UST FRN yields would more than likely still be close to or above the current fixed coupon Treasury yields.

The Bottom Line

When looking to position their fixed income portfolio, in my opinion, investors should consider using USFR as a strategic lynchpin, as it “checks the boxes” for a variety of rate outlooks.