There's a fierce debate raging on Wall Street: Will a key U.S. benchmark rate continue to rise, threatening the finances of thousands of companies and consumers?
Analysts at Deutsche Bank and TD Securities have staked out opposite positions on the outcome. But companies with the most at stake don't seem overly concerned; they appear to generally believe this benchmark will stabilize relative to other rates.
The benchmark in question is not the Federal Reserve's much-discussed overnight interest rate but rather three-month U.S. Libor, which has steadily risen ahead of new money-market rules going into effect on Friday. As much as $6.9 trillion of debt is pegged to this rate, including hundreds of billions of dollars of speculative-grade corporate loans.
Libor has risen to the highest level since 2009, even though the Fed's benchmark has stayed constant. Given this discrepancy, it would be logical for companies to rely less on markets that are pegged to Libor and instead issue debt in fixed-rate markets that are more influenced by the fed funds rate.
But that's not happening. In fact, companies have only accelerated their issuance of floating-rate debt. For example, new U.S. leveraged-loan sales have steadily ticked up in recent months.
Why would these companies keep coming back to the leveraged-loan market if they thought they'd be paying a materially higher rate in the near term? Yes, they may opt to hedge their floating-rate risks through derivatives, and yes, they want to diversify their financing sources, but that's not the whole story.
In many cases, they're still receiving a competitive rate in the loan market, even with the rising floating rate. That's because a growing number of investors have piled into this debt, with the goal of capturing bigger yields as Libor rises. This has meant that the extra spread above the benchmark has narrowed materially over the past six months, offsetting Libor's rise.
Meanwhile, companies don't appear to be particularly worried about Libor surging much further. The Fed doesn't seem keen to raise its benchmark rate all that much, and there will probably be some reconciliation between Libor and the fed funds rates at some point.
In the past few months, billions of dollars have flowed out of funds that invest in short-duration corporate debt because of the new money-market rules, which would allow the net asset value of such funds to fall below par. The outflows may continue. But at some point, investors will start to return to these funds, attracted by the now higher yields, especially if other rates don't increase.
The Fed has indicated it's paying attention to Libor's rise, and companies should keep a close eye on it as well. But they appear to have concluded that Libor's wrecking ball has already done most of its damage.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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