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May 20, 2023

Are We There Yet?

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May 20, 2023

Are We There Yet?


Market Insights

Are We There Yet?

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May 20, 2023

 
 

Federal Reserve Board1
The Federal Open Market Committee (FOMC) voted unanimously to increase the federal funds target rate by 0.25% to a range of 5.00% to 5.25% at the conclusion of its May meeting. The press release was relatively unchanged from the prior meeting; however, it now includes a softer stance on forward guidance. Concerns around regional banks continued to flare as J.P. Morgan purchased First Republic Bank after U.S. regulators took control. Market participants believe the Federal Reserve (Fed) is now on hold as it interprets incoming data, with employment remaining tight and inflation still running above target.

European Central Bank1
At the European Central Bank’s (ECB) policy meeting on May 4, President Lagarde and the policy committee increased the ECB deposit rate by 0.25% to 3.25%. The Governing Council noted incoming data supports their views on medium-term inflation as the rate hikes the past few meetings are impacting monetary conditions. In terms of forward guidance, the ECB is maintaining its “data-dependent” approach and remains committed to bringing down inflation.

Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to increase the Bank Rate by 0.25% to 4.50% at its May meeting. The two dissenting members preferred to keep the rate unchanged at 4.25%. MPC members noted economic activity has been below expectations and now projects demand to be "materially stronger" than initially expected in February. The MPC noted that the labor market remains tight but has "started to loosen." Inflation posted above expectations at 10.2% in the first quarter of 2023. The BoE projects inflation to fall well below 2% in the "two- and three-year horizons." The committee continues to monitor inflation and will adjust policy as needed to bring it down to its 2% target.

 
 
DISPLAY 1
 
Monthly Interest Rate Summary
As of 4/30/23
 

Source: Bloomberg

 
 
DISPLAY 2
 
MSILF Weighted Average Maturities (WAM) Summary as of 7/31/22.2
 

Source: iMoneyNet 

 
 

PORTFOLIO STRATEGY

GOVERNMENT/TREASURY STRATEGY
Similar to March, elevated volatility throughout April allowed us to incrementally add callable agency debt across our funds, extending duration along with our peers into the high-teens. Against these purchases, we opportunistically sold some short-dated floating-rate notes that had richened to negative discount margins, as well as some agency discount notes maturing in June ahead of an expected Fed rate hike in early May.

We expect the Fed to be nearing the end of its hiking cycle but unwilling to change stance until officials see tangible evidence in either the jobs market or the inflation data. This view is complicated by the lingering effects of the March banking crisis and subsequent sale of First Republic Bank at the end of April. This will likely cause caution among the committee, and all eyes will be on the early May Fed statement for guidance on a path forward. The U.S. Treasury has continued to use cash-management bills to meet periodic funding needs as they pop up and as the debt-ceiling limits take hold. We have no concerns with liquidity in the Treasury bill market currently. Similar to March, issuance sizes will likely begin to decrease with sporadic cash-management bills as debt ceiling considerations come into play.

PRIME STRATEGY3
In April, the portfolios’ WAM (weighted average maturity) and WAL (weightedaverage life) increased as we deployed excess cash built up throughout the prior month when there was heightened volatility in the market. As spreads normalized throughout April, we opportunistically deployed capital in both fixed- and floating-rate formats at entry points that we felt fairly compensated the funds based on expectations for near-term monetary policy.

We find value in both fixed- and floating-rate securities across the money market curve. While spreads continue to normalize, they remain well off their early March 2023 lows, and if the updated Fed dot plots look to be accurate—likely hiking one more time at the May FOMC and then holding constant throughout the remainder of the year—then extending both duration and spread duration offers attractive opportunities right now. For longer-dated maturities we continue to prefer floating-rate securities as they offer a measure of downside mitigation in the event the Fed tightens more than anticipated by the market.

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. We remain constructive that liquidity continues to normalize as investors deploy excess cash and volumes increase in the wholesale funding market.

TAX-EXEMPT STRATEGY3
Short-term municipal rates continued to experience volatility in April. The SIFMA Index,4 which measures yields for weekly variable rate demand obligations (VRDOs), initially dropped during the first two weeks of the month before snapping back as dealer inventories rose mid-month with redemptions related to tax payments. Yields at the longer end of the municipal money market maturity range also rose over the course of the month.

The WAM on the portfolio was little changed in April we looked to maintain high liquidity during tax season. Overall, the portfolio is well positioned for a rising rate environment, with a short duration and high concentrations in VRDOs and floating-rate securities.

Municipal yield movements are closely tracking the Treasury market’s high volatility, and it will likely require a calming of that volatility, as well as a more favorable technical municipal backdrop, to reignite persistent market conviction and sustained outperformance.

 
 

1 Source: Bloomberg.

2 Weighted Average Maturity (WAM): Measures the weighted average of the maturities of the portfolio’s individual holdings, taking into account reset dates for floating rate securities.

3 The Portfolio will be required to price and transact in their shares at a floating net asset value (“NAV”) and will be permitted to impose a liquidity fee on redemptions or temporarily restrict redemptions in the event that the Portfolio’s weekly liquid assets fall below certain thresholds.

4 The SIFMA Municipal Swap index is a 7-day high-grade market index comprised of tax-exempt VRDOs reset rates that are reported to the Municipal Securities Rule Making Board’s (MSRB’s) SHORT reporting system.

The views and opinions expressed are those of the Portfolio Management team as of April 30, 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%

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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Please be aware that liquidity instruments may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In the current rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest-rate environment, the portfolio may generate less income.

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