Libor Swell Seen as Respite From Bonds With Negative Yieldsby
Brean Capital is adding floating-rate debt to its portfolio
OppenheimerFunds boosts holdings of commercial paper
Some investors are buying more floating-rate debt, wagering that a spike in a short-term borrowing benchmark brought on by pending rules will be permanent.
Brean Capital LLC is adding corporate bonds and collateralized loan obligations, and is looking at mortgage-backed securities that are pegged to the dollar London interbank offered rate, according to Scott Buchta, head of fixed-income strategy at the company. OppenheimerFunds Inc. is adding commercial paper tied to the three- and six-month benchmark, according to Krishna Memani, the chief investment officer of the money manager, which oversees $223 billion.
Any uptick in Libor pulls with it as much as $6.9 trillion of debt, which includes mortgages, student loans and corporate loans, according to Goldman Sachs Group Inc. The rise in the benchmark stands out in a world where yields on pretty much everything are being crushed by central bank stimulus spanning Europe, Japan and the U.K. With about $9 trillion of mostly sovereign debt yielding negative worldwide, investors are streaming into U.S. dollar assets in search for income.
“Structural changes to Libor as well as money market fund rules are going to permanently elevate the benchmark rate,” Buchta said. “It makes sense to add exposure to Libor. And we expect more and more investors to swoop in as October nears.”
October is when rules designed to make money-market funds safer go into effect. The upcoming regulations have made the funds, which are a source of short-term funding, less desirable and have boosted Libor.
The three-month dollar Libor has risen to 83 basis points, the highest since 2009 and surpassing levels seen at the height of the sovereign-debt crisis in Europe, according to data from the ICE Benchmark Administration. That level may remain elevated also due to signals from the Federal Reserve that the case to raise interest rates is getting stronger as the U.S. economy approaches the central bank’s goals.
The pending reforms and a potential Fed rate hike means, “floating rate securities can provide increased income benefits as well as protection from increases in short-term interest rates,” said Seth Roman, who helps oversee five funds with a total of $3.2 billion in assets at Pioneer Investments. The company is adding floating-rate securities tied to Libor and has delivered more income for investors who are in one its ultra-short funds, he said.
The Fed may see rise in Libor as a “temporary phenomenon,” Steve Kang, a strategist at Citigroup Inc., said in a note . The Fed may only be concerned about the increase if borrowing rates remain high after the money market reform compliance deadline passes and “other conditions tighten along with it,” he said.
There’s still room for Libor to ”grind higher” potentially ending the third quarter at 95 basis points, JPMorgan Chase & Co. strategists led by Alex Roever wrote in note dated Aug. 26. There are $169 billion of bank commercial paper and certificates of deposits scheduled to mature before Oct. 14. and Libor is poised to rise depending on the extent banks choose to refinance those into shorter tenors with prime money market funds, or longer durations with non-traditional money market buyers, the strategists wrote in the note.
For Memani of OppenheimerFunds, the rise in the benchmark has boosted the appeal of commercial paper, a short-term funding used typically by banks. Rates on AA rated financial companies’ three-month commercial paper reached 0.9 percentage point this month, the highest since 2009.
“That has been a good trade,” he said.
The trade may be limited by the fact that rising borrowing costs have made the commercial-paper market less appealing for borrowers. Companies have reduced their reliance on the short-term securities and the size of the market has shrunk by more than $100 billion since May, according to Fed data.
“We’re taking advantage of it while it does,” Memani said.
With about $169 billion of commercial paper and certificates of deposits scheduled to mature before Oct. 14, in addition to new paper issued in August, there’s room for Libor to “grind higher” potentially ending the third quarter at 95 basis points, JPMorgan Chase & Co. strategists led by Alex Roever said in note.
The way Libor is calculated is also changing, after nearly eight years of scandals found the the method for setting the rate wanting. This shift in the way it’s worked out will also help elevate the level, according to Buchta.
The rate is based on a daily survey of about a dozen big banks that estimate their short-term borrowing costs. Traders were revealed to have manipulated submissions to boost their numbers, culminating in record fines for collusion by banks. The Intercontinental Exchange, a network of regulated exchanges and clearing houses for financial and commodity markets, published a report in March recommending a broader set of data submissions should be included in the calculation.
Rising Libor is also boosting the appeal of leveraged loans because they’re pegged to Libor. CLOs, which bundle loans into bonds of varying risk and return, also stand to benefit because the interest on those securities is also tied to Libor.
The highest-ranking notes backed by payments on leveraged loans “offer value,” Brean’s Buchta said.
Mutual funds that buy loans have seen inflows during the last four straight weeks, the longest streak of deposits in at least 16 months, according to Lipper U.S. Fund Flows data.
“As Libor goes up, you’ll see more investors getting into the floating-rate space,” Craig Russ, a portfolio manager at Eaton Vance Corp., said. “It’s providing a nice yield today, ahead of a hike.”