This Bond Is A Loser For Investors

In January 2014, the U.S. government 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 government use of their money and provide almost no interest in return.

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!

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 return.

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 government, but I don’t see it.

Of course, the entire argument against these securities and their 0.075% yield rests on the notion of earning 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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Categories: Bonds

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.