Why Floating Rate Funds Are Losing Their Shine: A Macro Perspective

The allure of floating rate funds like the BGF Floating Rate Income Fund (BGT) has dimmed as macroeconomic conditions and structural shifts in leveraged loan markets erode their appeal. Once favored for their ability to thrive in rising-rate environments, these funds now face headwinds from a Federal Reserve poised to cut rates, softening inflation, and underlying vulnerabilities in the credit markets. Here's why investors should think twice before jumping in—and where to look instead.

The Fed's Pivot: From Hikes to Cuts

The Federal Reserve's shift from rate hikes to potential cuts by late 2025 has flipped the script for floating rate instruments. As of July 2025, the federal funds rate has held steady at 4.25%-4.50%, but projections suggest two 25-basis-point cuts by year-end, with further easing in 2026.

This trajectory undermines the core premise of floating rate funds, which benefit most when short-term rates rise. With cuts likely, the income streams from loans tied to benchmarks like SOFR or LIBOR will shrink. Meanwhile, the Fed's balance sheet runoff—reducing liquidity by $40 billion monthly until early 2026—adds another layer of uncertainty, squeezing yields in already tight credit markets.

Structural Challenges in Leveraged Loans

Floating rate funds like BGT hold a significant portion of leveraged loans, which face their own set of problems. While the broader credit market remains stable, sectors like student loans are seeing rising delinquencies, a red flag for funds with exposure. The research highlights that credit quality has diverged:

• Sector Risks: Student loans, a major part of some loan portfolios, face default rates climbing to 8% in late 2024—double pre-pandemic levels.
• Liquidity Pressures: The Fed's balance sheet reduction has tightened funding conditions, making it harder for issuers to refinance debt.

This creates a “perfect storm” for leveraged loan investors. Even if defaults remain contained, the combination of weaker pricing power and rising refinancing costs could crimp returns.

The Opportunity Cost of Staying Put

Investors in floating rate funds are also facing stiff competition from alternatives. For instance, high-quality bonds and dividend-paying equities now offer more predictable returns in a slowing growth environment.

Meanwhile, the Fed's cautionary stance—pausing hikes to assess inflation—means short-term rates won't spike unexpectedly. This removes a key risk premium that once justified floating rate exposure.

Investment Implications: Proceed with Caution

1. Avoid New Money in BGT: With rate cuts on the horizon, the fund's income-generating capacity is likely to decline.
2. Focus on Quality Credit: If you must stay in the credit space, prioritize investment-grade bonds or ETFs like LQD, which offer stability amid Fed easing.
3. Consider Inflation-Linked Bonds: TIPS (e.g., TIP) hedge against any inflation surprises without the credit risk of leveraged loans.
4. Monitor Tariff Risks: Geopolitical developments could reignite inflation, but the Fed's “wait-and-see” approach means rate cuts aren't guaranteed. Stay nimble.

Conclusion: Time to Rethink Your Floating Rate Exposure

The days of easy gains in floating rate funds like BGT are fading. With the Fed set to cut rates and structural issues lurking in loan markets, investors should reassess their allocations. For now, the smart money is moving toward safer havens—or waiting on the sidelines until the macro outlook crystallizes.