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Bond of the Week: 5 September 2007
Money market rates surge higher.......................    
        

Money market rates continue to surge higher with Tuesday’s close for 3-month LIBOR (the London Interbank Offered Rate) at 6.7975%, an eight year high and slightly above the BOE’s offer of emergency funding at 6.75%.

It is fair to say that the credit crunch is underway, and yesterday’s 6.8% rate for LIBOR should be viewed against the context of a steady 5.75% base rate. At present, LIBOR is 1% over this base rate, whilst a more normal spread might be in the region of 1/8% of a percent.

The interbank market is the first port of call for most institutional funding requirements, and this sharp increase in the cost of funding is placing considerable strain on financial institutions who have built up portfolios based on the cheap and easy funding availability seen over the past few years. Assuming the scenario continues for the next few months, here are our thoughts on tactics for fixed income investors:

  • Cautious investors should stick to Gilts. These are the instruments that have shown the best performance recently, and will continue to show the best price performance if the credit crunch continues.
  • Long term investors should consider very high quality quasi-government debt such as European Investment Bank (rated AAA) bonds. These types of bonds have also suffered from spread expansion, but in the long-term offer absolutely rock solid assurance of the return of capital.
  • More risk-positive investors should start accumulating bargains in non-governmental bonds. If the funding squeeze continues, forced sellers of bonds will appear. Consider the credit risk and look to diversify across sectors.
  • Consider floating rate notes*; here the coupon is based on a margin to LIBOR, and thus coupon rates are rising accordingly. By selecting an issue that has just passed its quarterly refix, coupon rates of 6.75%-7% are available, at least for the next few months. As an example, the Allied Irish Bank (Aa2/A+) FRN 20 Feb 2012 pays 7.5bp over LIBOR, and fixed its coupon last month at 6.72%. The bond trades slightly under par around 99.70. These types of instruments allow investors to take advantage of the current high money market rates.

 

*Note , FRN’s typically trade on a peer-to-peer basis between financial institutions and can be hard to access by private investors. Minimum denominations (usually £50,000) usually apply and it may be hard to deal in sizes below £1 million.


Mark Glowrey

The next Bond of the Week will be published on Wednesday 19th September.                   

    
    
    
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