Steve Wagner: Steve Wagner, I'm a Senior Portfolio Manager and Senior Analyst at Federated Hermes.
Interviewer: How is the potential for rising short-term rates and heightened inflation affecting the bank loan market?
Steve Wagner: We've clearly seen a number of inflation indicators that are above a comfort level in recent months. And oftentimes that can really be a harbinger of a strengthening economy which we think that we're seeing right now. But it also brings about the prospect for rising short-term rates. We've been in a zero interest rate environment for some time and since the COVID downdraft of 2020. So, the big question on a lot of investor's minds is when will the Fed act and when will the Fed start to increase short term rates? While we don't have a crystal ball, we think that is likely to play out at some point.
Steve Wagner: So, how does this affect the bank loan market? Well, the bank loan market essentially is made up of instruments that, where coupons are tied to floating rates. So, as short-term rates rise, the coupon on a bank loan will rise in lockstep with the rise in short term rates. That inherently is why the bank loan market has limited interest rate duration. So, we see that as a pretty decent backdrop for bank loans and especially relative to other fixed income options that might be more negatively reactive to rising short-term rates. We also think that rising inflation, well we're in a period of time right now there's a lot of debate, whether the inflation is more temporary or whether we have longer-term structural inflation. Time will tell to see how that plays out. But, inflation tends to be a reasonable backdrop as long as it's good inflation, meaning that can be good for leveraged borrowers and their businesses.
Steve Wagner:Our concern is, and we're not saying that this is the case, is that if inflation ramps up much higher and for much longer than the fed expects, what this could mean for risk markets. But with that said, we think that the overall bank loan market again, has very good credit fundamentals, tends to be very reactive in rising rate environments and holds up very well relative to other fixing them options in these environments.
Views are as of Nov. 16, 2021 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Duration is a measure of a securitys price sensitivity to changes in interest rates. In addition to the risks generally associated with debt instruments, such as credit, market, interest rate, liquidity and derivatives risks, bank loans are also subject to the risk that the value of the collateral securing a loan may decline, be insufficient to meet the obligations of the borrower or be difficult to liquidate. Variable and floating rate loans and securities generally are less sensitive to interest rate changes but may decline in value if their interest rates do not rise as much or as quickly as interest rates in general. Conversely, variable and floating rate loans and securities generally will not increase in value as much as fixed rate debt instruments if interest rates decline. Federated Investment Management Company 21-40583 (12/21)