September 21, 2021
Central Banks Tighten Their Messaging
September 21, 2021
Federal Reserve Board1
While the Federal Open Market Committee (FOMC) did not formally meet in August, Chairman Powell spoke at the annual Jackson Hole Economic Symposium. At last year’s conference, Chairman Powell outlined changes to policy including average inflation targeting, which in effect lets inflation run temporarily hotter. This year he hinted at the timing for a policy action. The Federal Reserve (Fed) chairman hinted that the Fed is likely to start reducing its monthly bond purchases before the end of 2021 as the economy and inflation have exceeded expectations. In addition, he stated that future rate hikes are neither tied to the pace nor the timing of the bond buying reduction. While inflation is a significant piece of the Fed’s dual mandate, Chairman Powell added, “we have much ground to cover to reach maximum employment.” For the Fed to raise rates, inflation will need to be solidly above 2% and maximum employment must be reached. However, the chairman also cautioned that COVID-19 continues to pose risks to the economy as the Fed monitors the impact of the delta variant.
European Central Bank1
The European Central Bank (ECB) did not hold a formal policy meeting in August. However, investors will want to pay close attention to the ECB’s September meeting as economic indicators and inflation gauges have moved upward recently.
Bank of England1
The Bank of England Monetary Policy Committee (MPC) voted unanimously to maintain the Bank Rate at 0.10% and voted 7-1 to leave the size of its U.K. government bond purchase program unchanged at the conclusion of its August 5 meeting. The MPC noted that inflation was likely to temporarily increase toward 4% in the fourth quarter of 2021 before settling back down to closer to 2%. The policy committee shares similar sentiment with the Fed, as both suggested hotter inflation data to be “transitory.” While COVID-19 restrictions are likely to impact third quarter gross domestic product (GDP), the BOE projects fourth quarter GDP to be at or around pre-pandemic levels. Moving forward, the MPC will monitor economic activity to ensure proper policy measures are taken and suggested that “modest” tightening may be necessary in the next two years.
Minutes from the July FOMC meeting released in August indicated that participants concluded their inflation goal had been attained while still needing to make progress on their employment mandate, stating that “Most participants judged that the Committee’s standard of ‘substantial further progress’ toward the maximum-employment goal had not yet been met.” Throughout the month, broader market volatility caused by concerns over the spreading delta variant did not flow through to the money market space, with 3-month LIBOR4 remaining range-bound near all-time lows. With a flat curve not compensating to extend maturities and take on additional credit and interest rate risk, we remain patient in our investment approach, waiting for dislocations in pricing before putting capital to work. Portfolio WAM (weighted average maturity) and WAL (weighted average life) organically rolled down throughout the month, with weekly liquidity remaining elevated in excess of 50%.
Overall Treasury yields remained similar to the prior month with most yields between 0.04% and 0.06% throughout the front-end curve. Bill auctions for late October through early November maturities stopped out 1-2 basis points higher due to some investor sensitivity near a potential debt ceiling limit date. There has been no legislation to address the debt limit yet as Congress continues to delay any resolution. We proactively sold Treasury positions we felt could be most at risk of a technical debt default. Given the lack of the market pricing in such risk, bids were competitive, and our portfolios had minimal yield impact to reinvest sale proceeds. Additionally, in our view, the risk of a potential deterioration of Treasury bids for those positions if market dynamics changed outweighed a “wait and see” approach. At month-end, the volume in the reverse repurchase agreement (RRP) facility hit a new high at $1.189 trillion on month-end, reflecting markets that are flush in liquidity. We continued to invest a significant amount of cash in overnight repurchase agreements and to manage the portfolios to be responsive to changes in market conditions and interest rate levels.
Municipal money market rates were virtually unchanged throughout August. At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) were little changed during the month of August. The SIFMA Index,6 which measures yields for weekly VRDOs, was unchanged at 0.02%. Yields at the longer end of the municipal money market maturity range were range-bound as well. The Bloomberg BVAL One-Year Note Index7 finished the month at 0.09%, up 0.03% from the prior month-end. It is possible ratios and credit spreads move lower in the coming weeks if volatility declines and a risk-on atmosphere returns to the macro landscape.