Should the U.S. Government Issue Floating Rate Notes?

Abstract

Since January 2014 the U.S. Treasury has been issuing floating rate notes (FRNs). We estimate that the U.S. FRNs have been paying excess interest between 5 and 39 basis points above the implied cost for other Treasury securities. With more than 300 billion dollars of FRNs outstanding, the excess borrowing cost for 2017 is estimated to be about 700 million dollars. We also find some evidence that foreign buyers at auctions are alloted relatively higher amounts as auction dates are closer to the end of the month; suggesting window-dressing motives. We examine the role of FRNs from the perspective of optimal government debt management to smooth taxes. In the model, bills can be cheaper to issue than FRNs, and the payoffs for FRNs are perfectly correlated with future short rates. FRNs can be used to manage the refinancing risk from rolling over short-term debt. Issuance of FRNs can optimally be positive, and this requires that the amount of short-term debt issued is relatively small.

Keywords: floating rate notes, fixed income arbitrage, tax-smoothing, optimal debt management

JEL Classification: E62, H63, F30, G12, G15