Floating Rate Notes: Safety in Higher Rate Times?
October 10, 2023
Watch Time 3:30 MIN
What does the Fed’s September decision to maintain rates mean for investors?
The [U.S. Federal Reserve’s] Fed's September decision to maintain rates means that interest rates are going to stay high for a longer period of time. The Fed decision was to leave interest rate and change at 5.25 to 5.50 until their next meeting in early November. The Fed is still very focused on bringing inflation back down to 2% and has mentioned that they will proceed very carefully as to what comes next.
In this higher for longer environment, investors looking for yield and safety may continue to find attractive opportunities in the front end of the curve. We continue to say and believe that investors should not “fight the Fed” and that investment rate floating rate notes are very attractive due to their enhanced yield and safety.
How does lack of lack of interest rate sensitivity affect floating rate note performance?
The lack of interest rate sensitivity is a positive contributor when rates move up for floating rate notes. And this is because floating rate notes offer a coupon that is equal to a spread over a reference rate, and that coupon resets with whatever the prevailing rate is at that time so their prices don't need to adjust. The end result is a very stable price for floating rate notes. This is very different to what happens to fixed coupon months.
Fixed coupon bonds see their price decline when rates move up and their price increase when rates move down. Because of their non-existent sensitivity to changes in interest rates, investment grade rate floating notes have strongly outperformed most fixed income over the past two years, and they're currently providing a higher yield than T-bills and floating grade notes issued by the U.S. Treasury.
Outlook
The outlook for the coming months is high interest rates will continue to bring inflation down, but will also slow economic growth and potentially have a negative impact on riskier buyers. Default rates have already started rising, and the market expectations are for a continued increase that's going to be driven by the lingering repercussions of rising interest rates. For investors looking for higher yield ultra-short exposure, we believe on two options.
One of them being CLOs, as they provide greater spreads with built-in risk protections, and the other one being investment-grade, floating-rate notes, as they are a more conservative option that provide exposure to a completely different set of issuers.
VanEck offer the VanEck IG Floating Rate ETF, Ticker FLTR, which offers exposure to investment grade corporate bonds, offering near-zero duration with enhanced yield potential.
To learn more, visit VanEck.com/fltr.
IMPORTANT DISCLOSURE
Indices:
IG Corporate FRN: MVIS US Investment Grade Floating Rate Index tracks U.S. dollar denominated floating rate notes issued by corporate entities or similar commercial entities that are public reporting companies in the U.S. and rated investment grade.
US Treasury FRN: ICE BofA US Floating Rate Treasury Index tracks the performance of floating rate US dollar denominated sovereign debt publicly issued by the US government in its domestic market.
3m Treasury: ICE BofA US 3-Month Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month.
1Y Treasury: ICE BofA US 1-Year Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month.
5Y Treasury: ICE BofA Current 5-Year US Treasury Index is a one-security index comprised of the most recently issued 5-year US Treasury note.
10Y Treasury: ICE BofA Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury note.
30Y Treasury: ICE BofA Current 5-Year US Treasury Index is a one-security index comprised of the most recently issued 30-year US Treasury note.
US Corporate: ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.
1-3Y US Corporate: ICE BofA 1-3 Year US Corporate Index x is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 3 years.
3-5Y US Corporate: ICE BofA 3-5 Year US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 3 years and less than 5 years.
1-5Y US Corporate: ICE BofA 1-5 Year US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 5 years.
10+ Y US Corporate: ICE BofA 10+ Year US Corporate is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 10 years.
US High Yield: ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
CLO: J.P. Morgan Collateralized Loan Obligation Index is the first rules-based total return benchmark for broadly-syndicated, arbitrage US CLO debt.
Leveraged Loans: J.P. Morgan Leveraged Loan Index is designed to mirror the investable universe of the USD institutional leveraged loan market.
Fallen Angels are represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”.
Broader High Yield is represented by the ICE BofA US High Yield Index, “H0A0”.
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