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2-year note auction coverage wasn’t great despite rising yields

Why Treasuries were strong while investment-grade bonds were muted (Part 4 of 9)

(Continued from Part 3)

Two-year notes

Last week, the U.S. Treasury department issued two-year fixed- and floating-rate notes. The two-year notes are generally announced around the third week of the month (usually on Thursday) and then auctioned the following week. In all cases, the two-year notes are issued (settled) on the last day of the month.

The two-year (VGSH) fixed-rate Treasury note with an issuance size of $32 billion was auctioned on March 25. The issuance bid-cover of 3.20x was slightly lower than the previous month’s bid-cover of 3.60x, indicating subdued investor’s interest. Bidding remained tight, but the yield offered was nearly 13 basis points above last month’s auction, which offered a yield of 0.34%. A richer yield of 0.47% (the market yield for two-year Treasury notes on the date of auction was 0.43%) appears to have boosted investors’ demand for the issue.

Non-dealers were awarded 62% of the $32 billion offering—a sizable share that points to strong participation from buy-and-hold accounts. The note is expected to mature on March 31, 2016.

Plus, despite the feedback by the Fed last week on the interest rate spike, the two-year floating rate (or FRN) note (TFLO) was under less demand. The auction held on Wednesday, March 26, was on the downside. The two-year floating rate note auction coverage came in at 4.67x, well down from 5.29x and 5.67x in the two prior auctions. The discount margin, in another sign of softness, came in near the high end of expectations, at 0.069%. Non-dealers were awarded only 37% of the $13 billion auction. The note has a maturity date of January 31, 2016.

A FRN (floating rate note) is a security that has an interest payment that can change over time. As interest rates rise, the security’s interest payment increases. Similarly, as interest rates fall, the security’s interest payment decreases. Floating rate notes (TFLO) offer investors a chance to gain yield when interest rates rise—and with short-term interest rates very low at the time of the introduction, they offer investors a low-risk, high-quality alternative to Treasury bills (BIL) and their associated rollover costs. On the other hand, in a rising interest rate environment, the FRN causes more risk to the government, as these short-term notes are exposed to the risk of a rise in interest rates—an increase that would add to the government’s borrowing costs.

Some of the relevant ETFs that track the U.S. Treasury market with an average maturity of one year or more include the following.

  • The Schwab 1-3 Year Treasury bond (SCHO): This fund has a net asset value of $471 million with an average yield of 0.30%. The fund tracks the price and yield performance of the Barclays U.S. 1-3 Year Treasury Bond Index SM. The year-to-date return of the ETF is 0.18%.

  • The Barclays Low Duration Treasury (SHY): This fund has a net asset value of $11.8 billion with an average yield of 0.26%. The fund tracks the Barclays U.S. 1-3 Year Treasury Bond Index. The year-to-date return of this ETF is 0.24%.

  • The Vanguard Short-Term Government Bond (VGSH): This fund has a net asset value of $504.4 million with an average yield of 0.23%. The fund tracks the Barclays U.S. 1-3 Year Government Float Adjusted Index. The year-to-date return of this ETF is 0.17%.

  • The iShares Treasury Floating Rate Bond ETF (TFLO): This fund has a net asset value of $5.0 million and tracks the Barclays U.S. Treasury Floating Rate Index.

Please read on to the next part of this series to learn more about the five-year Treasury (IEF) auction last week.

Continue to Part 5

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