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In the midst of a volatile week punctuated by the Federal Reserve's reluctance to provide additional monetary stimulus to the economy, the United States Treasury made an announcement that a floating-rate note program may be in place by this time next year.

The U.S. Treasury Department said today it is developing a floating-rate note program that could be operational in a year or more, while it is preparing for possible negative-rate bidding.

The Treasury also plans to sell $72 billion in notes and bonds in next week's refunding, it said in a statement in Washington. The Treasury intends to auction $32 billion in 3- year notes on Aug. 7, $24 billion in 10-year notes on Aug. 8 and $16 billion in 30-year bonds on Aug. 9.

The floating-rate notes would be the first new U.S. government debt security since Treasury Inflation-Protected Securities, known as TIPS, were introduced in 1997. With a budget deficit estimated at $1.21 trillion this year, the Treasury needs to expand its base of investors, and the notes may appeal to those who are seeking to protect themselves from a possible increase in interest rates or faster inflation stemming from the Federal Reserve's unprecedented stimulus.

Though this does represent additional risk for the Treasury if interest rates rise (which, after the global economy recovers, they most likely will from today's highly depressed levels), officials state that the increased reliability of capital from satisfied investors will merit the additional risk burden.

Like other floating-rate notes, the variable rate U.S. Treasuries would most likely adjust the rate paid periodically; this would give the government much more flexibility in when to float debt on the bond market. Many analysts have discussed the idea of sovereign floating-rate notes over the last months and years, but the general impression is that Wednesday's announcement was a bit of a surprise.

Treasury had discussed the idea of floating-rate notes for the past year, but the final decision to issue them surprised many analysts.

The Treasury Borrowing Advisory Committee, a panel of securities industry experts who advise the government on debt issues, predicted "strong, broad-based demand" for floating-rate notes.

The Treasury has an incentive to issue the new securities because it is facing a spike in debt issuance as a result of the Federal Reserve's Operation Twist program. The Fed is now selling short-term Treasurys that it used to reinvest in Treasury auctions.

Though the specifics of the program and implementation details will be hammered out over the course of the next year, authorities were quick to assure that the variable-rate notes would not in any way be tied to LIBOR, in the midst of recent scandals surrounding rate-fixing at major banks around the world. Still, the question remains: to which representative interest rate index will these floating-rates notes be tied?

The next months will no doubt bring a great deal of analysis on this decision by Treasury officials, but some in the financial world are delivering their opinion on the issue already, claiming that U.S. taxpayers will be shortchanged by this decision. Investors in the fixed-income markets will see their choice of sovereign debt investment securities expand; financial firms will benefit significantly due to the potential lower liquidity levels of these floating-rate notes. In the best-case scenario for the U.S. Treasury, the average maturity on its debt issues would increase due to high investor demand for these longer-term notes.

Clearly, many questions remain. Will these new securities be integral or secondary components of existing fixed-income ETFs like the PIMCO Total Return ETF (BOND), the SPDR Barclays Capital Long Term Corporate Bond ETF (LWC), the iShares Barclays Government/Credit Bond ETF (GBF), the SPDR Barclays Capital Intermediate Corporate Bond ETF (ITR), the SPDR Barclays Long Term Treasury ETF (TLO), the SPDR Barclays Intermediate Term Treasury ETF (ITE), and others, or will new products and exchange-traded funds emerge on the market to deal with higher-than-anticipated demand? Only time will tell. In any case, the next year will yield some extremely interesting insights on both the global macroeconomic situation and the workings of the U.S. Treasury with respect to sovereign debt.

Source: Floating-Rate Treasuries: What Should Bond Investors Expect?