Fed policy may keep leveraged-loan yields high
If the economy continues to grow and tariffs drive prices higher, the Federal Reserve is unlikely to pursue aggressive rate cuts, which could create a supportive environment for leveraged loans, says Fidelity’s Eric Mollenhauer.
- Policy priorities of the current administration and the Fed’s reticence to cut interest rates may help to keep leveraged-loan base rates and yields relatively high for some time, according to Fidelity Portfolio Manager Eric Mollenhauer, who says loans offer an attractive yield compared with other income-oriented investments.
- “Although we can’t predict the direction of interest rates, we believe the base rate for loans could remain elevated,” says Mollenhauer, who co-manages Fidelity Advisor® Floating Rate High Income Fund with Kevin Nielsen and Chandler Perine.
- The fund is a diversified leveraged-loan strategy focused primarily on loans that banks have made to non-investment-grade companies. Employing a core investment approach, the managers seek companies they believe have strong franchises and assets, adequate liquidity, operating flexibility and a solid management team.
- With the yield on the Morningstar LSTA US Performing Loan Index hovering above 8% as of June 30, Mollenhauer believes loans remain an appealing investment option, even if the Fed were to cut rates a few more times.
- “Given their leverage, the companies we lend to generally perform better when the economy is growing, even at a lower rate like today,” he explains. “Fewer Fed rate cuts should keep the base rate for loans relatively high, in our view.”
- Longer term, Mollenhauer thinks the trend may be for short-term rates to remain elevated compared with the historical average. Key indicators the managers monitor – such as the interest-rate swap curve for the Secured Overnight Financing Rate (SOFR) – also reflect this expectation, he says.
- Leveraged-loan yields consist of a base rate derived primarily from SOFR plus a spread above that rate. As of June 30, the base rate was about 4.3% and the spread was roughly 4.1 percentage points.
- “In light of ongoing negotiations with major U.S. trading partners, market volatility is likely to continue,” Mollenhauer says. “Still, given our long-term focus, market pullbacks give us the opportunity to buy loans we like at a lower price. Whatever challenges the market presents in 2025, we’ll remain vigilant in our credit selection, emphasizing what we consider to be our research team’s best ideas.”
Fidelity Advisor Floating Rate High Income Fund (FFRIX)
Seeks a high level of current income.
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