November 15, 2022
Are We There Yet?
November 15, 2022
Federal Reserve Board1
The Federal Open Market Committee (FOMC) voted unanimously to increase the federal funds target rate by 0.75% to a range of 3.75% to 4.00% at the conclusion of its November meeting—the fourth consecutive meeting with such a large interest rate increase. The committee expects the target range to move higher to “attain a stance of monetary policy that is sufficiently restrictive.” The press release mentioned that FOMC members understand changes in policy rates impact the economy on a lag and that they will “take into account the cumulative tightening” when assessing the necessary terminal rate.
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on October 27, President Lagarde and the policy committee increased the ECB deposit rate by 0.75% to 1.50%. The Governing Council retained language from prior meetings stating it “expects to raise interest rates further.” September inflation reached 9.9%, far exceeding the policy committee’s 2% goal. The ECB is focused on and committed to reducing demand as it grapples with several crosscurrents that have increased demand and exacerbated price pressures.
Bank of England1
At its November meeting, the Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to increase the Bank Rate by 0.75% to 3.00% in response to elevated inflation. One of the dissenting votes preferred a 0.50% increase while the other dissenting vote preferred a 0.25% increase. The MPC projects GDP to decline by 0.75% in the second half of the year with inflation touching 11% in the fourth quarter. Tighter financial conditions paired with elevated energy prices are likely to have a material impact on spending. Therefore, the committee anticipates GDP may decline through the first half of 2024. Risks remain skewed to the upside in the near term as inflation becomes increasingly more persistent. The MPC offered a clear stance regarding forward guidance, noting further rate increases may be “required.”
As of October month-end, the market was pricing in a 75 basis point rate hike at the November FOMC (which did materialize as expected), with another 50 and 25 basis points in December 2022 and February 2023, respectively. With expectations that the Fed will continue to tighten monetary policy in the near term, we remain comfortable managing the portfolios with elevated levels of liquidity and a short duration profile. Allocations to daily resetting SOFR (secured overnight financing rate) and OBFR (overnight bank fund rate) floating-rate notes continue to benefit the portfolios as their coupons reprice immediately following each rate hike and help meet our objectives of capital preservation and liquidity.
Government/Treasury Strategy Yields pushed to new cycle highs in October, as data releases showed the Federal Reserve (Fed) has made little progress in denting inflation or cooling the jobs market. Rising rates continued to pressure foreign exchange markets globally, causing large-scale currency intervention to take place as reserve managers sold Treasuries to raise cash. While much of October was spent speculating on and waiting for the upcoming November FOMC meeting, the back half of the month shifted to a tone of hesitation on just how far the hiking cycle will be able to go. Rates markets wrestled with financial stability headlines, as well as some foreign central banks taking their foot off the rate-hike gas pedal. This caused rates out longer in the curve to retreat from peak levels. However, as of the end of October, the U.S. market remained primed for a 75 basis point hike in early November. Within our funds, the focus remains the same: seeking high levels of liquidity and a short duration profile as we progress through this cycle and await more information from the Fed.
Tax-Exempt Strategy Continuing a trend noted in the prior few months, long duration municipal assets underperformed shorter duration by a wide margin in October, with the Bloomberg Municipal Long Bond Index returning -2.17%, compared with +0.13% for the Bloomberg index for one-year municipals. The long end of the municipal market adjusted meaningfully wider in the last week of the month. The return of the primary calendar brought excess supply and saw new issue concessions grow as outflows from bond funds persisted.
At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) decreased during the month, driven lower by a preference for shorter duration assets. The SIFMA Index,4 which measures yields for weekly VRDOs, declined 22 basis points to finish the month at 2.24%. At the longer end of the municipal money market maturity range, yields rose modestly over the course of the month. The Bloomberg BVAL One-Year Note Index5 increased 6 basis points finishing the month at 3.10%. Our portfolio is well positioned for a rising rate environment, being short duration with high exposure in VRDOs.
One basis point = 0.01%
The Bloomberg U.S. Municipal Bond Index is an index that covers the USD-denominated long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. It is composed of approximately 1,100 bonds.
The index performance is provided for illustrative purposes only and is not meant to depict the performance of a specific investment.
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