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Rising Rates Might Mean It's Time to Float

7 June 2013 in Trading Ideas

Throw the recent chatter from the Federal Reserve that it may be close to ending its bond-buying program1 on top of the fact that 10-year Treasury yields have recently spiked to 14-month highs, and it’s enough to make fixed-income investors fret about how they’ll navigate what appears to be rising interest-rate environment.

Here’s one alternative: Our new Floating-Rate Bonds motif, a portfolio of ETFs with an investment strategy of holding shorter-maturity, floating-rate notes that seek to lower an investors’ interest-rate risk.

Floating-Rate Bonds

Think of floating-rate bonds as the fixed-income cousin to an adjustable rate mortgage. Their coupon rates adjust as short-term interest rates change. And, for investment-grade “floaters” that tends to mean monthly or quarterly adjustments to the portfolios of the ETFs. The shorter the time between resets, of course, the greater advantage that these bonds, and related ETFs, can offer in a rising interest-rate environment.

The question that follows, naturally, is are we in a rising-interest rate environment, or rather, are we in one to the extent that will function as a boon to investors in floating-rate bonds?

Certainly, the rise of the 10-year note yield to its highest level since April 2012 – above its 200-day average – suggests that rates may be putting a near-term floor behind them. Similarly, one could understand investors taking the recent comments from the Fed as evidence that their willingness to keep the hammer on interest rates until 2015 is somewhat less than all-out enthusiastic.

That said, it’s perhaps worth wondering how much the spike in Treasuries had to do with last month’s headlines trumpeting historical stock index highs. It’s worth noting that the 3% dip in stocks since May 28, has coincided with a stall in the 10-year’s recent rise.

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In addition, Schwab analyst Collin Martin recently noted that floating-rate issuance surged in the first two months of this year vs. a year earlier, a sign that corporations (who, this just in, are seeking terms in their best interest) don’t anticipate an immediate uptick in rates.2

If you do, this new motif might be worth a look.

1Johan Carlstrom & Aki Ito, “Fed’s Williams Sees Potential QE Taper This Summer,” Bloomberg.com, June 3, 2013, http://www.bloomberg.com/news/2013-06-03/fed-s-williams-says-sees-potential-qe-taper-by-summer-.html.

2Collin Martin, “The Time Is Not Yet Right For Floating-Rate Bonds,” schwab.com, April 4, 2013, http://www.schwab.com/public/schwab/resource_center/expert_insight/schwab_investing_brief/fed_and_bonds/times_not_yet_right_for_floating_rate_bonds.html, (accessed June 5, 2013).

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  1. 10 Jun at 10:57 am

    I found your post very interesting and informative. Thanks for giving an insight on Floating rate bonds. Great job!

  2. Susan
    28 Jun at 11:33 pm

    I found your post very interesting and informative. Thanks for giving an insight on Floating rate bonds. Great job!