U.S. investors have bought $272.2 million of structured notes tied to the London interbank offered rate this month, the most since August, as investors prepare for the Federal Reserve to eventually begin lifting benchmark rates.
Morgan Stanley issued $250 million of two-year notes tied to three-month U.S. dollar Libor, the largest such offering in Bloomberg data going back to 2010. The securities, sold Feb. 13, yield 1.3 percent the first year, then 0.75 percent more than Libor with a 5 percent annual cap, according to a prospectus filed with the Securities and Exchange Commission.
The Federal Open Market Committee reiterated in January that it would keep the federal funds effective rate between zero and 0.25 percent as long as inflation isn’t forecast to rise to more than 2.5 percent and unemployment stays above 6.5 percent. The five-year U.S. breakeven rate, which measures expectations of inflation, has risen to 2.32 percent from 2.07 percent on Jan. 1.
“I don’t think that most investors are anticipating Libor will be much higher come two years from now, but many investors do believe that once the Fed passes the mid-2015 date, that Libor could rise slowly,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. The benchmark rate is “very correlated” to dollar Libor, the rate that banks say they pay to borrow from each other, he said.
Three-month dollar Libor this year has dropped to 0.288 percent from 0.306 percent on Dec. 31. U.S. investors bought $1.6 billion of notes tied to the benchmark last year, 41 percent less than in 2011, Bloomberg data show.
All the Libor-tied notes sold this year yield a percentage above the rate, after paying an initial fixed coupon, Bloomberg data show. Morgan Stanley leads all banks with $276 million of sales of such securities, followed by Royal Bank of Canada with $130.1 million of volume.
Issuance of notes that lock investors into set rates has declined this year, Bloomberg data show. Banks sold $153.8 million of step-up callable securities in January, half of last year’s monthly average. The bonds typically have maturities between 10 and 20 years, with the issuer holding an option to call them on certain dates.
Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.
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