With yields up, CPI floaters may be back in style as HSBC readies the first one in a year

By Emma Trincal

New York, Feb. 12 – With recent signs of increased inflation rattling the markets, investors are likely to pay renewed attention to inflation-linked notes, sources said. There has not been any pricing of a note linked to the Consumer Price Index in the past 12 months, according to data compiled by Prospect News.

HSBC USA Inc. may lead the way if it prices next week its announced floating-rate notes due Feb. 28, 2025, according to an FWP filing with the Securities and Exchange Commission.

The interest rate will be equal to the year-over-year change in the Consumer Price Index plus a spread of 50 basis points, subject to a minimum interest rate of 0%. Interest is payable monthly.

The payout at maturity will be par.

Hedge

“This is a pure inflation hedge. It’s a direct exposure to the rise in inflation and your coupon increases accordingly if prices move higher,” a market participant said.

“Treasuries can’t give you that. And TIPs pay fixed interests, which are lower.”

With Treasury Inflation-Protected Securities, or TIPS, the principal increases with inflation. When a TIPS matures, investors receive at least par plus the positive adjustment in principal if any, which could be positive or negative, depending on whether the environment is inflationary or deflationary.

“Rates are not as high with TIPs. With a CPI floater, your rate is going to be really good if there’s inflation. That’s the whole point,” the market participant said.

Rarely done nowadays

With the zero-interest rate environment and the Federal Reserve’s dovish monetary policy, inflation-based floating notes issuance has nearly vanished in recent years.

The last CPI floater was brought to market a year ago by Wells Fargo & Co. and priced for $2.61 million, according to data compiled by Prospect News.

There were no such deals in 2016. In 2015, only two CPI-linked notes hit the market. Citigroup, Inc. issued one for $8 million. It was a 10-year deal paying a coupon of 1.38 times the year-over-year change in the CPI. The other was Goldman Sachs Group, Inc.’s $2 million of 20-year notes based on the CPI increase plus a 155 bps spread, according to the data.

In comparison 63 offerings totaling $781 million priced in 2011 a year that saw a peak in gold prices associated with inflation fears.

“I haven’t seen a lot of these types of notes in a long time,” said a fixed-income analyst.

“When the prospect of inflation was so muted, until very recently, you couldn’t see any of those products. Now that the theme is popular again, you’re going to see a lot more.

“It’s amazing how quickly these products get priced when the firms see demand for it.”

An aging world

The notes are designed for investors who fear inflation. For inflation skeptics, the notes make little sense however.

“Even if inflation rises, it’s not going to rise very much,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

In his view the tax cuts are not going to provide Main Street with the economic boon so many are expecting.

“The money is not going to go to the economy. Corporations are going to pay dividends; they’re going to do share buybacks. These are not things that favor growth.

“Fundamentally we’re in a low-inflation environment and have been for a long time now presumably because of demographics. As the population is aging, inflation will remain contained.”

He said better alternatives exist for yield, such as real estate investment trusts, some of which can have returns as high as 10%.

He conceded that REITs, which are equity securities, offer no downside protection.

“But how much are you going to give up for principal protection?” he said.

That is not to say that investors cannot protect their principal themselves.

“I would make a little more with a REIT even if I factor in the protection. I could buy a put on it. After all, these products are a combination of puts and calls around a fundamental view. That’s all,” he said.

Alternatives

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, was also slightly doubtful.

“We had for 10 years people worried about inflation. Nothing has happened,” he said.

“Do I think we’ll have inflation? Yes. Do I believe we’ll have runaway inflation? No.

“The Fed is very cognizant of the risk of inflation.”

His two main objections were the lack of liquidity associated with the structured notes as well as the credit risk exposure.

Rather than having a variable rate, Chisholm said he would rather use the issuer’s plain vanilla corporate bond.

“You have the same credit risk exposure and it’s more liquid,” he said.

To improve the credit profile, Chisholm said he would be looking at U.S. Treasuries or alternatively at certificates of deposits, which benefit from the Federal Deposit Insurance Corp.’s insurance.

“My feeling is that you could find a better credit with probably a better yield.”

Inflation will be at the center stage of this week’s economic data. The monthly CPI figures will be released on Wednesday and the Producer Price index, the following day.

Morgan Stanley handles distribution.

The notes will price on Feb. 23 and settle on Feb. 28.

The Cusip number is 40435FTX5.

© 2015 Prospect News.
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