Time to Dig Floaters from the Back of the Bond Closet
(Bloomberg Gadfly) -- Tapering is coming, and forward-thinking investors are wearing floaters.
The European Central Bank is going to have to start tapering its quantitative easing program before the end of the year. It's been a long time coming, and it may be a slow affair, but this time it's for real. And investors are starting to believe it.
The classic hedge against higher rates is the floating-rate note. That they're now becoming more popular makes perfect sense -- they make up 8 percent of Europe’s syndicated issuance so far this year, up from 6 percent for all of 2016.
Investors in UBS AG's 3 billion-euro ($3.6 billion) offering this week demanded that the lead managers keep up with the times. The bank had at first marketed a tranche of 2-year fixed notes, but buyers said they'd prefer floating rate securities instead, and that's what they got.
Floaters are a safety net when interest rates rise. Priced off of 3- or 6-month Euribor, they reset each quarter to the current rate. If interest rates move up then so does their price, as it factors in the next uptick in the quarterly coupon. Fixed-coupon bonds do the opposite and fall in price when rates are rising. Investors need to smooth out their portfolio performance when central bank policy shifts, so a bit of variety is a smart move.
They're a common sight in the U.S., where they appear regularly in larger corporate bond deals, and U.S. Treasury auctions them quarterly. But they've been pretty rare in the European non-financial market since the crisis, when ever-lower central bank rates put them right out of fashion.
So it's worth watching that they're featuring prominently in recent new issues. Koninklijke Philips NV sold a two-year floater on Thursday and received bids for eight times the 500 million euros on offer, allowing it to shave more than 7 basis points off the final pricing. British American Tobacco Plc's megadeal last month included a four-year euro-denominated floater, and even AT&T Inc. got in on the action with its European issue in June. It's all evidence that bondholders want some rate protection beyond the extra spread for the credit risk.
With the end of easy central bank policy in sight, floating-rate notes look like they'll be all the rage again.
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Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.