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August 14, 2023

A Hop, Skip and a Pause

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August 14, 2023

A Hop, Skip and a Pause


Market Insights

A Hop, Skip and a Pause

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August 14, 2023

 
 

Federal Reserve Board
The Federal Open Market Committee (FOMC) voted unanimously to maintain the federal funds target range at 5.00% to 5.25% at the conclusion of its June meeting. This is the first time since March 2022 that the committee left rates unchanged. Market participants are attempting to grasp whether this signals a longer-term pause in policy rate movements.

The June meeting included an update of the Federal Reserve’s (Fed) summary of economic projections. The dot plot showed officials’ median projection for the benchmark rate at the end of 2023 increased 0.50% to 5.6%. The 2023 median gross domestic product (GDP) growth projection was upgraded 0.60% to 1.0%. The 2024 GDP growth forecast was lowered slightly to 1.1%. The 2023 unemployment rate estimate decreased 0.40% to 4.1%. The Fed reduced its median 2023 personal consumption expenditure (PCE) inflation forecast to 3.2% in June, from 3.3% in March. The 2024 PCE projection was unchanged at 2.5%.

European Central Bank
At the European Central Bank’s (ECB) policy meeting on June 15, President Lagarde and the policy committee increased the ECB deposit rate by 0.25% to 3.50%. The committee increased its inflation projections and now forecast headline inflation to average 5.4% in 2023. The ECB plans to maintain its data-dependent approach and is committed to bringing down inflation. 

Bank of England
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to increase the Bank Rate by 0.50% to 5.00% at its June meeting. The two dissenting members preferred to keep the rate unchanged at 4.50%. Market participants were slightly surprised as markets had priced a greater chance of a 0.25% increase. The MPC decided to hike more aggressively as inflation continues to run above expectations. Consumer price index (CPI) inflation posted at 8.7% in May, which was 0.30% above expectations. Services CPI inflation came in 0.50% above expectations, at 7.4%. The BoE noted core goods inflation remains elevated and “stronger than projected.” The committee continues to monitor economic conditions, adjusting policy as needed as it commits to bringing down inflation.

 
 
DISPLAY 1
 
Monthly Interest Rate Summary
 

Source: Bloomberg

 
 
DISPLAY 2
 
MSILF Weighted Average Maturities (WAM) Summary
 

Source: iMoneyNet

 
 

PORTFOLIO STRATEGY

Government/Treasury Strategy
June brought an onslaught of supply with the resolution of the debt-ceiling saga. This supply was heavily focused in short tenors (1-month, 3-month, 6-week cash management bills) and was taken down quite strongly by buyers – in fact, demand was better than most of the market anticipated. We will see if this persists through the remainder of the summer as investors return to their post-debt ceiling, steady state exposures and as dealer balance sheets start to swell from the consecutive offerings of increased issuance.

Although our investment philosophy remained opportunistic when we were compensated for the rate hikes to come, we largely remained patient in Treasuries, which needed to cheapen up more, as the Fed indicated likely two more hikes this year. We added Treasury floating-rate notes across the portfolio to benefit from increased post-debt ceiling issuance as well as the likely hikes to come. Our Treasury Securities portfolio shortened in June as a result of the normalization post debt ceiling, where we had avoided shorter dates for the sake of prudence.

All eyes are on inflation data and jobs data – both of which will indicate just how close the FOMC is to a holding pattern. The end of the hiking cycle is certainly closer, but inflation has previously shown its ability to remain resilient, making a few more hikes still likely at this point. Although the Fed conducted a “hold” at its last meeting, Fed-speak has indicated much of the policy committee remains concerned with the elevated levels in inflation and suppressed unemployment. Future decisions will become increasingly data dependent, and we expect another hike at the July FOMC meeting.

Prime Strategy
In June we deployed cash on hand resulting from organic June FOMC maturities and excess liquidity that we had built up heading into June in anticipation of potential debt ceiling volatility. We prioritized adding fixed-rate exposure in the 3- to 6-month month tenors, while floating-rate note maturities were isolated to the 6- and 9-month tenors. Weighted average life (WAL) increased materially month-over-month as a result of new investments. It does not change our overall thesis of seeking to ensure that we’re being compensated to add duration, focusing on the final maturity dates for fixed-rate securities to coincide with the dates of those FOMC meetings most likely to hike interest rates, and adding floating-rate notes for longer maturities.

The Fed continues to stress that it will remain data dependent and keep rates in restrictive territory until inflation returns to the 2% longer-run objective. We continue to use the newly released dot-plot as our base case path for monetary policy, with two additional interest rate hikes penciled in for the remainder of the year, before easing in 2024. With the futures market now pricing out all rate cuts in 2023 – which is much more in line with Fed expectations – we remain comfortable purchasing both fixed- and floating-rate securities across the money market curve. We remain confident targeting floating-rate notes with 2023 maturity dates because they offer a downside buffer to the portfolio in the event the Fed has to tighten more than anticipated, but will also organically mature out of the portfolio by year-end when the Fed is likely done raising rates and the next move is lower.

Liquidity remains strong and dealer balance sheets remain unconstrained as spreads have been generally stable over the past couple months. As we likely enter the final stages of this tightening cycle, we remain thoughtful about security selection, seeking to ensure we are purchasing the most liquid securities in the appropriate formats, while opportunistically adding duration when there is a dislocation in market pricing.

Tax-Exempt Strategy
Short-term municipal rates continued to experience some volatility during the month of June. The SIFMA Index, which measures yields for weekly variable rate demand obligations (VRDOs), closed the month at 4.01%, 45 basis points higher than May as a result of above-average dealer VRDO inventories. The Bloomberg Municipal Bond 1-Year Total Return Index posted a 48 basis point return for June, reversing negative returns seen in April and May.

The WAM and WAL on the portfolio increased as a result of better fixed-rate opportunities and in anticipation of upcoming strong seasonal technicals. We took advantage of the inversion of the Bloomberg Municipal AAA Callable curve by adding some high-grade tax-exempt commercial paper.

 
 

The views and opinions expressed are those of the Portfolio Management team as of July 31, 2023 and are subject to change based on market, economic and other conditions. Past performance is not indicative of future results.

 
 
 
The Global Liquidity team aims to effectively meet clients’ unique cash and working capital needs, offering a broad range of money market funds, ultra short bond funds and customized separate account solutions.
 
 
 
 
 

One basis point = 0.01%

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