Finimize - ✈️ A US-approved ETF landed in Europe

What’s going on here?

Wednesday’s US inflation reading was the lowest since early 2021 – but, accustomed to disappointment, investors still focused on the negatives.

What does this mean?

Consumer prices in the US were 2.5% higher this August than last – a touch below what economists were forecasting and a nice step down from July’s 2.9% pace. But investors must have left their rose-tinted glasses behind. They seemed to focus on the unexpected pickup in monthly “core inflation”, which strips out volatile food and energy prices. Economists had expected the measure to flatline, and the surprise may be why investors initially dipped out of the S&P 500.

Why should I care?

The bigger picture: Nothing’s ever simple.

Remember, the Federal Reserve (Fed) has two main jobs: to keep price increases under control and the labor market in check. So now that inflation is slowly edging closer to its 2% target, the central bank is focusing on recent signs of weakness in the jobs market. The latest report showed that over the last three months, the pace of hiring in the US slowed to its lowest level since the start of the pandemic in 2020. That explains why the Fed’s widely expected to lower interest rates by 0.25 percentage points next week, with some traders predicting a chunkier 0.5 percentage point trim.

Zooming out: Bottom of the barrel.

The US and China are the world’s biggest consumers of oil – so with their economies in less than fighting strength, the price of the slippery stuff has slumped over the past month. Just this week, oil prices hit their lowest level since December 2021 after OPEC – the group of the biggest oil-producing countries – lowered its demand forecast for the second time in two months. That’s a concern for the cartel, sure, but it bodes well for central banks: lower energy prices could help take the remaining sting out of inflation.

What’s going on here?

Europe’s first-ever exchange-traded fund (ETF) for collateralized loan obligations (CLOs) dropped this week, to the delight of many wide-eyed investors.

What does this mean?

Think of CLOs as a sort of smoothie – just less delicious than Erewhon’s famous lineup. Banks whip together a mix of different loans, portion them into batches with different risk levels, and serve them up to thirsty investors. The loans are often issued to private equity-backed companies with less-than-perfect credit ratings. And they typically have a “floating” rate, where the interest those companies pay changes based on what rates are doing in the overall economy. Now, ETFs based on CLOs have been storming the US: already this year, they’ve attracted five times the investment they saw in all of 2022. But because Europe has stricter regulations, the Fair Oaks AAA CLO ETF (FAAA) – known for its high-quality risk ratings – was only just deemed worthy of becoming the region’s first CLO fund.

Why should I care?

For markets: Safety first.

The FAAA fund only holds “AAA-rated” loan obligations – the type that haven’t seen a default since they debuted in 1999. And while the riskier CLOs hand out the thickest returns, the safer ones still seem to have an edge over rival assets. So far this year, European AAA CLOs have delivered returns of 3.6%, compared to a measly 0.6% from investment-grade bonds.

The bigger picture: That’s so yesterday.

The timing of this launch isn’t exactly ideal. Interest rates are on the slide in Europe, which could take the shine off CLOs. See, their payouts increase as interest rates rise, and vice versa. That’s not the case for fixed rate bonds: their value increases as rates drop, so they could win investors’ attention in a falling-rate climate. So if you’re considering CLOs, you’ll need to decide whether the market has already factored in lower rates. If not, you might be burned by yesterday’s news.