JPMorgan’s $1 million floaters on CPI to provide inflation hedge, bond replacement

By Emma Trincal

New York, Oct. 27 – JPMorgan Chase Financial Co. LLC’s $1 million of floating-rate notes due Oct. 23, 2023 surprised market participants for its short tenor, bond-like characteristics and inflation hedging attributes.

Interest will be equal to 1.05 times the year-over-year change in the Consumer Price Index, subject to a floor of 0%. Interest will be reset and payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus accrued interest.

Rate of return

Scott Cramer, president of Cramer & Rauchegger, Inc., said the notes would be a good fit for risk-adverse investors.

“For a one-year note with guaranteed principal, you’re taking little risk and you should outperform Treasuries,” he said.

“Inflation would have to fall fast for you to underperform the risk-free rate. I don’t think it’s going to be the case. I think inflation is going to be sticky.”

The CPI in September rose 8.2% over the last 12 months, according to the latest release from the Department of Labor on Oct. 13.

This CPI rate multiplied by the 1.05 factor would give noteholders an interest rate per annum of 8.61%.

Different version

“Your only risk is credit exposure. But JPMorgan is not going anywhere and it’s a shorter-term note. I’m not concerned about illiquidity,” he said.

The one-year duration made the product very competitive, he added.

“It’s a much better place than a bond.”

Traditionally, CPI-linked notes were structured as fixed-to-floaters with a capped interest rate and a much longer maturity of at least 10 years, according to data compiled by Prospect News. This year, issuers have priced shorter CPI notes, but their tenors were usually of at least five years, the data showed.

Futures pricing

With inflation at a 40-year high, traders are betting that inflation is more likely to go down than up, he said.

“They were able to buy the call options at a cheap enough price because people are pricing inflation going down on a year-over-year basis,” he said.

“It’s still worth taking the risk. Within one year, I think the CPI rate is going to be sticky. The worst that can happen is break even.”

Cramer said the absence of a cap on the interest rate did not surprise him.

“Nobody believes the CPI is going up a whole bunch. Every world leader is focusing on fighting inflation. The Fed is very cognizant of it. They’re working against it. It’s not going to go down fast. But it’s not going to keep on rising either.”

Fixed-income substitute

The notes, given their monthly coupon and principal-protection, could be used as a bond-like instrument, a financial adviser said.

“For a conservative investor it’s an alternative to cash. You can get a return without losing your buying power,” he said.

“The only risk is if the CPI drops. But right now, the note gives you more than 8%. Even if the rate of inflation dropped by half, you would still get 4%. I think it’s okay.”

Short duration

The duration set the notes apart from traditional fixed-income instruments, he noted.

“The one-year term is very attractive,” he said.

“People are losing the motivation to invest as the stock market is under pressure. But they may want to reinvest at some point and not too far from now.

“With this product, they have the option to reinvest in one year without having to sell.”

Another obvious benefit of the shorter duration was to reduce interest rate risk, he said.

This adviser recommended comparing the potential yield of the notes with that of traditional bonds.

“Right now, Treasuries offer more than 4%, which is more than half what the note is paying right now. And Treasuries do not hedge inflation while this product obviously does.

“If you’re looking for a bond substitute with a decent yield and some protection against inflation, it’s probably the way to go.”

Protecting value

A market participant said he liked the notes in the current inflationary environment.

“It seems like a nice inflation hedge. You’ve got the principal-protection, just like a bond. But you’re not locking yourself up for 10 years. I don’t know where you can find a better inflation hedge actually,” he said.

He cited real estate, noting that the asset class is now “too risky” as prices are beginning to cool.

Commodities, seen as the traditional hedge, were not best. “Commodities prices are all over the place,” he said.

He mentioned the I Bonds offered by the U.S. Treasury and designed to hedge inflation. But there again, the flaws offset the benefits.

“I Bonds were paying a 9.62% coupon but starting Nov. 1, it’s going to drop to 6.47%. Plus, they’re a pain in the neck because you can only buy $10,000 per person, or $15,000 if you use your tax refund. That’s very limited.

“This note is a much better hedge than anything I’ve seen.

“I’m surprised they were able to do this.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities Inc. is the agent.

The notes settled on Monday.

The Cusip number is 48133PAF0.

The fee is 1%.

© 2015 Prospect News.
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