Sinking Floaters

Economists estimate that three-month Libor will rise to a whopping 0.59% by the end of next year. If you own Libor floaters, or fixed-to-floats which will begin floating in the interim, the Street forecast should be somewhat troubling. As most Libor floaters have long maturities or are perpetual, they tend to trade off of the long end of the curve when the yield curve is steep. If the forecasts are even close to correct, Libor floater coupons will rise about 15 basis points. The yield of the long bond will rise about 70 basis points and the yield of the 10-year note is expected to rise by about 80 basis points by the end of 2013. Price drops of four or five points would be possible in such a scenario, while investors receive little in the way of increased income. Some fixed–to-float bonds could see their coupons decline, resulting in less income and more severe price declines. Many floating-rate instruments have had a good run, albeit for not necessarily the right reasons. One might consider taking profits now and re-entering the floater market after the curve has steepened. If you have invested in floaters for income purposes, you might wish to sell your floaters and include the proceeds in a bond ladder. We have found that there is no better hedge for changing rate and curve conditions than a well-constructed customized bond ladder.