Variable-Rate Treasuries: An Investor's Best Friend

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In an effort to maximize low-interest-rate borrowing potential, the Treasury Department will begin issuing floating-rate securities:

The Treasury Department said Wednesday that it will offer investors Treasury securities with variable interest rates, similar to those on some home mortgages. [...] The government's decision to offer variable-rate securities represents officials' belief that the risk of paying higher rates in coming years is worth it because of the benefits from attracting more investor demand initially.

While in normal circumstances I am not sure how I'd feel about such bonds, in the current low-interest-rate environment, I believe investors seeking a "safe haven" should take advantage of these new securities if the current macro environment persists into next year (when the Treasury will begin selling these variable-rate bonds).

Here's why.

I've been very critical of 10- and 30-year Treasury bonds and bond funds such as TLT, for several reasons. First, investors are agreeing to lose money to inflation until the maturity date. Second, when (not if) interest rates rise, investors will be subjected to a significant "haircut" on the price of their bond, which will force them to either sell at a loss or hold until maturity. With a more favorable macro backdrop, both of those options would leave a bad taste in investors' mouths.

On the other hand, a variable-rate bond could allow investors to capture the "safety" of a Treasury bond without having to worry about the above factors. While coupon payments will be negligible in the short term, as I stated, interest rates will rise eventually—it's impossible for them not to. Since the bond's coupon payment is floating, the bond should theoretically retain most or all of its value as interest rates rise. This provides investors with short-term safety (preservation of capital) without locking them into the absurdly low rates offered by today's bonds.

The Treasury won't be offering these bonds until next year, because it will take a significant amount of time to get the new computer systems set up. In a year, perhaps the economic problems facing us will be resolved or, at the least, muted. In such a scenario, interest in bonds might not be quite as heightened as it is now. Nonetheless, in an environment where interest rates are likely to stay flat or rise over the long term, I believe variable-rate bonds would make the most sense to investors, providing true security and safety. That's something fixed-rate bonds can't do right now, due to interest rate risk.

Disclosure: I am short TLT.