FIXED INCOME STRATEGY

Float like a butterfly

Aug 2, 2017
By Jeffrey Rosenberg, Rich Mejzak, CFA, Thomas Musmanno, CFA

Expectations for rising rates are taking hold globally as policymakers react to a synchronized and sustained global expansion and abandon emergency levels of policy accommodation. Rising rates boost the appeal of floating rate assets. We see risks, and advocate a
defensive stance.

Fixed income highlights

  • Floating rate notes have a built-in hedge against monetary tightening; rate rises are passed on through regular coupon resets. The market-implied path of future Fed tightening points to a restoration of yields on floating rate and short-term debt, and this is already quietly underway.
  • It is critical to distinguish between different types of floating rate debt. Bank loans, for example, offer relatively attractive yields but come with prepayment and credit risk. Low default rates of late and a positive economic backdrop support the asset class, but tight valuations and declining investor protections are challenges.
  • We see selected opportunities in bank loans but our stance is defensive. Within high yield we prefer bonds over loans. Our overall stance within and across credit markets is up-in-quality. We also like selected emerging market debt (EMD).

Snapshot

There is an expanded menu of options for investors seeking shelter from rising rates, spanning an array of income and risk, as the chart shows. Floating rate bank loans have the highest yields, though their higher income potential comes with greater credit risk. We can also see that yields have narrowed across the risk continuum, and this reflects increases in the Federal Reserve’s rate path and investors’ pursuit of higher yields.

Flavors of floating rate
Floating rate asset yields, 2017 vs. 2016

Chart: Floating rate asset yields, 2017 vs. 2016

Source: BlackRock Investment Institute, with data from Bloomberg, Morningstar, S&P and bankrate.com, July 2017.
Notes: Current yield (green bar) as of June 30, 2017. All yields in U.S. dollars. Yields for Treasury and corporate floating rate notes, floating rate asset-backed securities (ABS) and short-duration bonds based on respective Bloomberg Barclays indexes; yield for bank deposits based on the national average three-month CD rate from bankrate.com; yields for non-traditional bond funds, government and prime money market funds based on the weighted average yield of the largest funds (those making up 80% of the total AUM of the funds in their respective Morningstar categories); yield for floating rate preferred stock based on the aggregated yield of the non-fixed-rated preferred equities in the S&P preferred stock index; and yield for bank loans based on the yield to worst from S&P LCD. Floating rate preferred stock is not truly floating rate; it has either a coupon floor well above current interest rates or a fixed-to-float coupon structure.

Jeffrey Rosenberg
Chief Fixed Income Strategist
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views ...
Rich Mejzak
Head of U.S. Portfolio Management, BlackRock’s Cash Management Group
Thomas Musmanno
Head, BlackRock’s U.S. Fundamental Short Duration Team