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A Trio for Rising Rates
09/12/2016 9:00 am EST
Though bond yields might be done going down at this juncture, they aren’t likely to spike higher either until wage and core inflation are trending higher on a sustainable basis, asserts income expert Bryan Perry, editor of Cash Machine.
Inflation expectations, as measured by the five-year forward break-even rate, returned into the bottom half of this year's range.
The 5-year, 5-year (5y5y) forward rate reflects the views of investors who have money on the line, and that index slid eight basis points to 1.59% last week after holding steady the first two weeks of August.
According to the Federal Reserve, the rate is well below last year's level of 1.96%, hovering 19 basis points above this year's low.
This is a tool the Fed pays close attention to and in light of recent robust jobs gains, inflationary pressures remain very tame.
To sum up, a do-nothing Fed and a sideways bond market is a green light for the bulls and especially for investors looking for near-term visibility.
It’s my view that a quarter-point bump in the Fed Funds Rate won’t move the needle on investor sentiment.
Meanwhile, many of our recommended holdings have adjustable rate features built into them.
Most of the business development companies (BDCs) have some degree of floating-rate weightings within their loan portfolios.
FS Investment (FSIC) has a portfolio that is made up almost entirely of floating-rate loans, if one is looking for a pure play on higher interest rates.
Commercial real estate finance companies like Starwood Property Trust (STWD) and Apollo Commercial Real Estate Finance (ARI) to a large extent underwrite deals that are structured with adjustable rate triggers built in.
If and when interest rates do rise, the interest earned from these specialty REITs and the BDCs will increase as those loans are reset to reflect any increase in short-term rates.
As such, these assets become more valuable in an up-rate market and while they are already paying yields of 8-10%, they will be yielding more going forward if rates start to adjust higher.
By Bryan Perry, Editor of Cash Machine
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