Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Chief Macro Strategist
The shortest-term government fixed income securities that mature within a year of issuance are called bills. These are not issued with a coupon, but are instead issued at a discount to par. The interest is paid as a function of the progress toward the price at issuance and the appreciation of the bill’s price as time transpires toward maturity. So, for example, if the 1-year yield is near 4%, a twelve-month US T-bill would be issued just above a price of 96, paying no interest but maturing at 100 on the maturity date 12 months later. If the holder sold the T-bill after six months and interest rates are still near 4%, the seller would realize a price of close to 98, i.e., close to 2% actual appreciation for half a year, or an annualized yield of 4%.
Floating rate bonds are bonds with a variable coupon. The coupon is typically reset every 3, 6 or 12 months at some level, or spread, relative to a benchmark rate. That benchmark rate is often a short term interbank rate for 3 to 12 months like EURIBOR, ESTR, SOFR, CIBOR, etc., or even a central bank policy rate.
These bonds typically trade very close to par, as the coupons mostly reflect the yields in the market as they are often reset. Floating rate bonds are interesting for investors wanting to receive the short term market yields (like now where yield curve is inverted, meaning that short yields are higher than long yields) while trying to avoid the risk of significant capital losses. This is because floating rate bonds usually are less volatile. Floating rate bonds are also of interest for investors that want to benefit from rising short term interest rates.
Why trade floating rate bonds/notes? The primary reason to consider these is avoiding significant capital losses if you aren’t sure you will hold even shorter maturity bond investments to par, but also if you are very concerned that yields are set to continue rising aggressively. Floating rate notes are available from both governments, local governments (many of these with very high credit ratings) and corporations.