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Staying fit for a new Fed
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Julius Bär
With uncertainty on the direction of US rates, flexibility may matter. A new investment idea offers enhanced income potential across different rate scenarios.
A new Fed, but which direction for rates?
The US economy continues to demonstrate resilience, while signs of a softer labour market suggest that wage-driven inflationary pressures have peaked. Although the Federal Reserve is not expected to embark on a rate-hike cycle, visibility remains low. With the new Fed chair displaying a hawkish bias towards inflation while largely refraining from forward guidance, changing expectations could keep interest-rate markets moving. For income-seeking investors, committing to a single interest-rate scenario may therefore be increasingly challenging.
Why choose just one rate scenario?
A floored floating-rate approach offers an interesting alternative. If short-term rates rise, investors can participate in the higher-rate environment up to a predefined cap, reducing interest-rate sensitivity compared with conventional fixed-income securities. Should economic conditions deteriorate and prompt the Fed to cut rates, an embedded coupon floor provides protection by preserving a minimum level of income. This creates the potential for enhanced income across different rate scenarios – without requiring investors to make a single big call on where rates are heading.
Balancing flexibility and risks
The combination of participation in higher short-term rates and protection through a coupon floor can offer a differentiated risk/return profile and a potentially smoother approach to income over time. Such flexibility does not remove risk entirely: participation in rising rates is limited by the cap, while investors remain exposed to issuer credit risk. However, for investors seeking an alternative to traditional fixed income or money market investments, this balance of income potential and resilience may be worth exploring.With the Fed entering a new chapter, could flexibility help keep your income strategy fit for what comes next?
Find out more about this investment idea.
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