2023-04-12 15:11:15 ET
Summary
- Floating rate notes are now offering 5-5.2% yields.
- Some of the highest money market accounts are offering 4.75% or less.
- Until interest rates begin to decline, variable rate bonds including FRNs offer an advantage.
During rising interest rates, floating rate bonds have distinct advantages. Specifically, Treasury Floating Rate Notes ((FRN)) offer these advantages with the risk profile of U.S. Treasury bonds. FRNs are a 2-year note that pays bondholders a variable yield equal to the most recent weekly 13-week Treasury bill rate and a spread rate set at issuance. The current spread is 0.2% and the latest 13-week rate was 5.128% so the rate on newly issued FRNs until the next auction is 5.228%.
The advantage is that floating rate notes will not lose value as interest rates rise because the rate on the FRN is reset weekly. As long as rates continue to rise, bondholders can expect higher payments without losing principal. The current spread on FRNs makes the yield even more attractive, when compared to short term fixed bills like the 3-month T-bill.
We use the iShares Treasury Floating Rate Bond ETF ( TFLO ) to gain exposure to FRNs in our portfolio. The fund has a portfolio of FRNs that have different spreads, depending on their issuance, resulting in a 30-day SEC yield of 4.8% and an average yield to maturity of 5.23%. Until the Federal Reserve begins to cut rates, FRNs will continue to be an important part of our portfolio.
Beating Money Market Yields
Over the past year, nearly $1 trillion of bank deposits have been withdrawn from U.S. commercial banks. Many of these deposits have been re-positioned into Treasuries and money market accounts as depositors are looking to improve their interest earned.
This is only logical, as bank savings account rates are failing to keep up with Treasury rates. Over the past year, the rate on the 3-month Bill has increased by over 4% while the average checking and savings account rate have barely increased by 30 basis points or less.
Comparatively, money market rates have improved a little more than checking and savings, but on average are still well below Treasury rates. There are some higher yielding money market accounts that come close. The top five highest yielding money market rates according to Bankrate.com include:
- Citibank - 4.75%
- Bask Bank - 4.65%
- Western - 4.55%
- My Banking Direct - 4.38%
- LendingClub - 4.25%
Money market funds are also variable rate and should be expected to fall when interest rates fall, similarly to FRNs. We prefer the yield and credit risk of Treasury FRNs which can earn nearly 50 basis points more than most money market funds.
Summary
Floating rates notes offer a solid yield and flexibility during periods of rising interest rates. Treasury FRNs are backed by the U.S. government and offer some of the highest short term interest rates available at 5-5.2% which is higher than most money market rates. Until rates begin to decline, which the market expects to happen later in 2023, we will continue to be positioned in TFLO.
For further details see:
TFLO: 5.2% Yield Beats Most Money Markets