USFR ETF: With The Market In Turmoil, Floating Rate Treasuries Deliver (NYSEARCA:USFR)

Thesis

On April 10 the March 2024 CPI data was released, numbers which came in higher than expected, triggering a red day in equities and a massive rally in bond yields. Sticky inflation has been a problem for the Fed, who might be forced down the line to make 3% the new long term inflation target. For now however, the market is starting to price out cuts for the year, with the odds for a June 2024 cut significantly lower:

The market is now pricing a 50% plus probability for easing in September only, which translates into higher front end rates for longer. While equities, and especially small caps, were pummeled yesterday together with bonds, there is one clear winner from the turmoil – front end treasuries and floating rate treasuries.

Higher for longer (or even no cuts in 2024) translates into the low duration treasury asset class outperforming for the foreseeable future, at enviable yields. In a scenario of no cuts in 2024, expect to make a total return over 5.3% from this asset class during the current year.

The WisdomTree Floating Rate Treasury Fund ETF (NYSEARCA:USFR) is an exchange-traded fund we first covered almost a year ago, when we described the fund structure, its composition and its usefulness as a portfolio allocator tool.

In this article, we are going to revisit the ticker in light of the current macroeconomic picture, and highlight to investors why receiving a risk-free 5.36% yield in today’s market for the foreseeable future is an extremely advantageous position.

Higher for longer makes USFR more attractive

USFR is composed of floating rate treasuries (structure fully described in our original article), securities which produce a 5.36% distribution yield with a negligible duration of only 0.02 years:

The floating rate component for Treasury FRNs resets weekly off 13-week Treasury bill auction yields, and thus is a direct take on Fed Funds. As long as Fed Funds stay high, the distribution yield will stay high for USFR.

An investor needs to understand USFR is a ‘cash-like’ vehicle, with virtually no risk. The fund has no duration, and is backed by the full faith of the U.S. government via its holdings. Making 5.36% without any risk might not be that bad when looking at various asset class performances so far this year:

Small caps as represented by the iShares Russell 2000 ETF (IWM) are now flat for the year, equal weight equities via the Invesco S&P 500 Equal Weight ETF (RSP) are up only 4.3%, while long dated bonds are down significantly. The S&P 500 is the only fund here posting attractive results, up 8.17% still.

Kindly keep in mind that all investments highlighted above come with significant risks and volatility, while USFR is a yield on your cash.

The best way to play a ‘no rate cuts’ scenario in 2024 is via USFR

While traders need to place outsized bets on rate cuts in order to make a profit, retail investors can take a different path:

The above trade in SOFR futures, placed before the CPI data was released, represented the biggest ever SOFR futures trade. The respective individual was betting on a softer than expected CPI figure, which would have caused the Fed to cut more than expected. The trade backfired, with the opposite occurring. The current market estimate for the above trade is a negative -$50 million loss.

A retail investor has a very easy and safe way to ‘bet’ on no cuts in 2024 – just buy USFR. As long as Fed Funds are high, USFR will deliver a very high yield with virtually no risk.

Risk for the fund can be assessed via the Seeking Alpha Risk tab for the name, which shows both an annualized volatility figure below 1%, and a standard deviation below 1.

When the market is in turmoil cash is king

Active investors tend to believe they always need to have a position, be it long or short, so that they can profit from every move in the wider capital markets. We do not subscribe to that view, strongly believing that a good portfolio hedge is represented by a high cash balance. When using options or inverse funds to speculate on a market crash, you end up spending capital. If your view is fulfilled you gain, while an inaccurate positioning results in a loss.

Having a high cash balance via a fund like USFR will a positive endeavor, with the fund delivering 5.3% irrespective of the short end fluctuations in equities. A high cash balance is an underrated portfolio hedge in our opinion, especially in today’s market which has defied all odds in terms of a recession materializing.

The resurgence in inflation is a surprise for everybody, us included, highlighting how difficult it is to predict the future. We do not think the Fed can hike this year again due to political reasons, but they can certainly make no cuts or maybe only 1 cut to appease the current president who interfered in central bank policy via his publicly stated opinion on April 10:

President Biden on Wednesday said that the March report on inflation, which ticked higher, may delay an expected interest rate cut from the Federal Reserve. Biden last month predicted the Federal Reserve will cut interest rates, a move that could give the president a boost ahead of November’s election while he campaigns on his work to improve the economy and combat inflation.

A measure of last resort would be for the Fed to cut by 25 bps in September just for optics, all while waiting out any further policy loosening in order to prevent inflation from spiking again.

Conclusion

USFR is an ETF that invests in floating rate treasuries, a niche asset class. Treasury FRNs have negligible duration profiles and a 1:1 correlation to Fed Funds. With inflation data coming in stronger than expected, the market is now moving towards fewer than 3 cuts for 2024, with many participants now expecting only 1 cut. While traders can gamble on outcomes via SOFR futures, retail investors can take the easy path of just investing in USFR, which will provide a total return in excess of 5.3% in 2024 if the Fed does not alter its target for Fed Funds this year.