Institutional investors in asset- and mortgage-backed bonds are looking to buy floating-rate bonds to defend against rate changes, but doing so too early is a costly option, market experts warn.
Bob Pucel, head trader at Royal Bank of Scotland told SI there could be a pickup in floating-rate securities as investors prepare for next year (SI, 12/17). The disagreement lies in when to start buying floating-rate bonds.
“We have been telling people to favor fixed- over floating-rate bonds, but my gut feel is that now that the Federal Reserve is going to taper, I would not be surprised to see demand for floating-rate pick up, even though I don’t see them raising rates for two years or more,” said Scott Buchta, head of fixed-income strategy at broker-dealer Brean Capital. “The cost of carry is still tremendous, so demand may not pick up until second half next year. I’d rather collect the carry that forward curves are giving me,” he said.
A life company money manager in charge of ABS purchases said his firm is “happy with floating-rate bonds, but they need to have sufficient carry.” The money manager said they prefer fixed rate right now because of the way the yield curve has steepened. “One month LIBOR is 17 basis points. The 10-year Treasury is under 290 bps. That’s a very steep curve.”
John McElravey, head ABS researcher at Wells Fargo, is also telling clients not to rush into floaters. “Floaters are an expensive option on rising rates,” McElravey in a conference call this week. “It may offer a hedge on rising duration, but not on rising rates.”
Floaters from benchmark issuers are unattractive for adding yield because LIBOR is unlikely to rise in 2014, he said. “One-month LIBOR is likely to be anchored at a low level. If the Fed doesn’t move rates until 2015, 1mL could be in the 15-20 basis point range for another year and a half,” McElravey said. Swap rates versus 1mL are still well below normalizing rates seen in 2010 and 2011 and they are likely to steepen even further, he added.
“Why do you care if short term rates aren’t going to move higher until 2015? Why not buy A1, A2 on a fixed-rate deal?” echoed a research co-head at JPMorgan.