Latest corporate debt deals offer inflation hedge

January 4, 2011

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

It may still be only a twinkle in investors’ eyes, but eventually easy money and a recovering U.S. economy will bring rising prices. A slew of floating-rate issuance by Corporate America’s heavyweights is giving inflation worriers an early chance to protect themselves.

The traditional go-to hedges have been gold and the U.S. Treasury’s inflation-protected securities, known as TIPS. But both have drawbacks. Gold has become the preferred vehicle for the world’s doom and gloomers, who see it as a refuge should the global financial system collapse. In a market whose small size makes it vulnerable to exaggerated moves, that makes some investors fear a bubble. The real yields on five-year TIPS, meanwhile, are currently in negative territory. That means some market players are so convinced that inflation will re-emerge over the next five years that they’re willing to accept short-term pain.

Lately, though, U.S. corporate titans like Berkshire Hathaway, General Electric and MetLife have given investors an arguably more palatable way to hedge inflation — through the simple means of issuing floating-rate debt. Accounting for more than 45 percent of the investment-grade corporate bond market in 2007, floaters became an endangered species in 2009, representing less than 5 percent of issuance, according to Thomson Reuters. That’s changing. More than a third of the GE finance arm’s $6 billion deal on Tuesday came in floating form.

Berkshire’s three-year floating-rate notes, which accounted for around a quarter of its $1.5 billion offering on Monday, priced to yield a meager 0.6 percent. But should inflation return, floating interest rates tend to track prices higher — increasing investors’ returns but also sparing them the big principal losses that can befall holders of fixed-rate debt.

Despite a flash flood of floating-rate supply in recent days, demand doesn’t yet appear particularly heavy. But that could change quickly when consumer prices make a decisive turn higher. Floating interest rate debt offers investors worried about inflation a place to comfortably brace for impact.

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