Pieter Staelens and Mitch Glynn
CVC Income and Growth

With the current market volatility caused by the conflict in the Middle East, investors can be forgiven for not being sure which way is up at the moment. The supply of oil and gas and the question marks over the safety of transit in the Strait of Hormuz has given rise to fears over inflation and has driven traders to bet on more interest rate hikes from the Bank of England and European Central Bank. Investors are keeping a close eye on the commentary from central banks in a bid to get insight into how the conflict is impacting their stance on monetary policy.

Markets are now pricing in two interest rate hikes this year by the BoE – an about turn from the two cuts they were pricing in before the first shots of this conflict were fired a month ago. With this being a difficult backdrop for central bankers to navigate and the likelihood inflation might tick up in the short term, some market analysts say inflation might not stay high for long, given the poor economic growth prospects for the UK and Europe, which is likely to cause downward inflationary pressure.

While this uncertain interest rate environment prevails, against an uncertain geopolitical backdrop, investors would do well to look at floating rate instruments. Floating rate assets – like loans – are often attractive in volatile environments for a few good reasons:

Protection against interest rate uncertainty

Unlike fixed rate bonds, floating rate instruments re-set their interest payments periodically (e.g. every three months) based on a benchmark like SONIA in the UK. This means that if interest rates stay higher for longer, or rise again, investors may benefit from a higher income rather than being locked in a lower fixed rate.

Reduced interest rate risk

These instruments tend to have low duration, so their prices are less sensitive to changes in interest rates. In a market where there is a lot of uncertainty around central bank monetary policy, the potential for stability from floating rate instruments is compelling.

Attractive income levels

Because base rates have been elevated, the yield on floating rate instruments is relatively high. So investors may effectively capture today’s higher rates without betting on where rates go next. Floating rate loans typically pay interest 3-4% above the respective central bank base rates. As interest rates move higher, the yield on the loans increases.

Inflation resilience

Floating rate instruments may give you some protection to inflation, to a degree. If inflation is sticky and keeps rates higher, floating rate coupons adjust upwards. That gives them a degree of protection compared to fixed income streams that get eroded in real terms.

In a nutshell, floating rate instruments are appealing right now because they offer potential for high income, plus flexibility and protection against rate volatility and inflation, to an extent.

This is precisely what investors need in an uncertain ‘higher for longer’ rate environment. This communication is provided for information only and should not be considered investment advice or a recommendation to invest. Past performance is not a reliable indicator of future results. Capital is at risk. UK investors only.