December 09, 2021
Fed Begins Tapering While BoE Defers Rate Hike
December 09, 2021
Federal Reserve Board1
The Federal Open Market Committee (FOMC) voted unanimously to keep the federal funds rate unchanged at a range of 0.00% to 0.25% at the conclusion of its November meeting. In line with market expectations, the Federal Reserve (Fed) announced it will start to taper its bond purchases in November. To start, the Fed will reduce purchases of Treasury securities by $10 billion and mortgage-backed securities by $5 billion per month. Purchases are anticipated to be reduced each month, but the committee “is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.” Additionally in November, Jerome Powell was reappointed as Federal Reserve chairman for a second term.
European Central Bank1
The European Central Bank (ECB) did not hold a formal policy meeting in November. However, investors will want to pay close attention to the ECB’s December meeting as inflation appears to be running hotter than the central bank’s projections earlier this year.
Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to maintain the Bank Rate at 0.10% and voted 6-3 in favor of leaving the size of its U.K. government bond purchase program unchanged at the conclusion of its November 4 meeting. The decision to hold rates steady came as a surprise to many as the MPC was expected to be first major central bank to shift interest rates higher since the pandemic started. The BoE cited uncertainty around the economic outlook as a main factor for leaving rates unchanged. Moving forward, the MPC signaled rate hikes were on the horizon, saying “it will be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.”
The Fed tapering its monthly purchase program is the crucial first step to clearing the way for potential interest rate increases in 2022. As a result of market expectations for the path of monetary policy in 2022, new issue offers in the commercial paper/certificates of deposit space in the 6- to 13-month tenors widened throughout the month. As the money market curve reprices with updated Fed expectations, we remain confident in our approach of remaining patient and waiting to deploy capital only after we feel we are being appropriately compensated for both interest rate and credit risk in the 2022 maturities. On the month we purchased both fixed- and floating-rate securities, with fixed tenors in the first half of 2022 and floating-rate securities with maturities in the second half of 2022, that reset off the SOFR index with coupons that will immediately reprice in the event the Fed hikes rates. Our portfolios ended the month with both WAMs (weighted average maturity) and WALs (weighted average life) on the lower end of the peer group, with weekly liquidity in excess of 60%.
During the month, there was no progress on a resolution to the debt ceiling. Treasury bills maturing in late December cheapened as investors priced this area as the new potential technical default zone, i.e., when the Treasury could run out of cash. While not reflected in market pricing, some participants believe the government’s cash balances could last through January. We remain vigilant of the recurring debt limit debate and think Congress is likely to address the debt limit before its December recess. While market expectations grew for a potentially sooner rate hike next year, the short Treasury curve has barely moved higher given the level of excess cash in the market. The 6-month and beyond segment of the curve cheapened, but short rates remained largely unchanged. We let the portfolios’ durations roll in by several days as we continued to invest a significant amount of cash in overnight repurchase agreements. We continued to manage the portfolios to be responsive to changes in market conditions and interest rate levels.
November municipal bond issuance rose 58.3% year-over-year as fears over rising rates brought issuers into the market, but the total $33.8 billion figure is an average level when considered over a 10-year period. While November volume rose year-over-year, supply still hasn’t kept up with demand, and participants are mixed on how much supply will rise in the coming months as factors outside the municipal space create more uncertainty for issuers. The net-negative supply currently at $9.83 billion, per Bloomberg data, is a key reason why municipals have outperformed U.S. Treasuries.
At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) were little changed during the month of November. The SIFMA Index,5 which measures yields for weekly VRDOs, was unchanged for much of the month at 0.05%. Yields at the longer end of the municipal money market maturity range were largely unchanged over the course of the month as well. The Bloomberg BVAL One-Year Note Index finished the month at 0.19%.