Author: Nick Peters-Golden

Treasury yields are all the rage right now, but with the Fed’s rate hikes continuing this week, getting the right exposure to Treasuries is important. As eyes turn towards short-duration Treasuries, it may be worth revisiting the ABCs of FRNs, or floating rate notes a unique flavor of Treasury offering available via the WisdomTree Floating Rate Treasury Fund (USFR) and its indexed approach to providing floating rate note yields.

Investors and advisors on the lookout for a way to play Treasury yields are increasingly looking at USFR, according to VettaFi’s advisor engagement data, with engagement for the ETF up 155% year over year (YoY). As inflation persists despite the Fed announcing yet another hike Wednesday, it remains a play popular with some advisors for the duration of the rising rate and inflation fight.

For more on inflation and FRNs: Hot Inflation Numbers? Eye Floating-Rate Treasuries

How do FRNs work, though? FRNs were introduced back in 2013 as the first new Treasury product since the Treasury Inflation-Protected Security (TIPS) in 1997. FRNs float, allowing their interest payments to change over time – rising as interest rates rise, and falling as interest rates fall.

Indexed to the most recent 13-week Treasury bill auction high rate, specific factors like the terms and conditions, as well as issue date and offering amount, are set before each auction, with initial auctions held for two-year FRNs in January, April, July, and October.

Functionally, an FRN is a bond, with many FRNs offering quarterly coupons that pay interest four times a year, though others pay monthly, semiannually, or annually. All that said, there is no guarantee the FRN rate will rise as fast as rates do overall in a rising rate environment like this, with so much dependent on the benchmark rate’s performance itself. That does mean that an investor holding an FRN still has some interest rate risk if the rate doesn’t keep up sufficiently.

In closing, FRNs tend to have less volatility and price valuations when rates rise as other fixed-rate bonds lose value, though due to the variable rates, coupon payments are sometimes unpredictable – advisors and investors would do well to check the maximum and minimum interest rates paid by each note, with some floating notes having caps and floors.

USFR presents a strong option when looking to get at floating rate note yields. Charging just 15 basis points, the strategy has returned 2% over the last six months according to YCharts, and may be a strategy to watch for FRN education and yields in the crucial weeks ahead for the inflation fight and ongoing uncertainty.

For more news, information, and analysis, visit the Modern Alpha Channel.

Amid the ongoing bank crisis, WisdomTree Investments hosted a webinar on Thursday titled “Navigating Market Headlines With Professor Siegel.” In the discussion, Professor Jeremy Siegel, senior investment strategy advisor for WisdomTree and emeritus professor of finance at the Wharton School, joined the firm’s head of fixed income strategy Kevin Flanagan and global CIO Jeremy Schwarz to discuss how the bank crisis has impacted the Fed’s approach to inflation.

Siegel described the bank crisis and its impact on the market as a “chill” equivalent to one or even two rate hikes from the Fed, with the tightening of conditions around lending substituting for a rate hike. That isn’t all bad news, he noted, adding that the important news from Federal Reserve chair Jerome Powell will be the forward guidance he will give rather than just announcing a zero or 25 basis point hike.

“This is, I think, the type of shock that Jay Powell and the Fed needs to realize that their tightening was one of the fastest in Fed history, and perhaps went too far,” Siegel said. “It would have been worse if they kept on hiking and hiking, and we had some big crisis in October with rates much higher. So in some sense, this is good news.”

Siegel noted that the chilling impact of the bank crisis and shock has made him more optimistic about 2024, even though the shock may result in lower GDP and perhaps lower earnings this year.

As for strategies for the moment, Flanagan brought up questions the shop has gotten about volatility and ways to play Treasury yields, with floating rate notes (FRNs) one route to consider. The WisdomTree Floating Rate Treasury Fund (USFR) invests in FRNs on a rolling basis, tracking a market value-weighted index of the securities, each with a two-year term. Charging 15 basis points, USFR has outperformed its ETF Database category average and FactSet segment average over the last three months.

“It’s like an ETF of a money market fund that pays these short-term high Treasury rates,” Siegel said of the strategy. “If you are worried about banks, I don’t think you have to be, but if you are worried about banks, these are Treasuries — U.S. Treasuries. So you’re getting a much higher interest rate on that.”

Siegel also touched on the debate surrounding quantitative tightening and the Fed’s decision to expand its balance sheet to support the banks, pointing out that the problem over the last week hasn’t necessarily been tightening, but instead the sharp inversion of the yield curve.

“There’s some talk about would they halt (quantitative tightening). You have to realize what they’re doing. They’re selling their Treasury bonds for the reserves,” Siegel said.

“Quantitative tightening really doesn’t have impact, unless they shrink that reserve base, which they blew up during the pandemic, to a level where they begin to impinge on the requirements that banks have for keeping those reserves. My understanding is that they’re nowhere near that at the present time,” he added.

The discussion surrounding the Fed is just the latest from Siegel, who has shared other thoughts on the fight against inflation in past webinar discussions. For those advisors looking for continued perspective on the topic, check out further commentary from Siegel here.

For more news, information, and analysis, visit the Modern Alpha Channel.