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June 25, 2023

Is Powell’s Peak Priced In?

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June 25, 2023

Is Powell’s Peak Priced In?


Market Insights

Is Powell’s Peak Priced In?

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June 25, 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 included a softer stance on forward guidance, but overall was fairly unchanged. Employment remains tight and inflation continues to run above the Federal Reserve's (Fed) target. Investors believe the Fed is on hold and data-dependent going forward; however, some believe a hike in June is possible.

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 ECB is maintaining its data-dependent approach and is committed to bringing down inflation. Incoming data supports the Governing Council’s views on medium-term inflation as the past few rate increases impact monetary conditions.

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%. Economic activity has been below expectations, but the MPC now forecasts demand to be “materially stronger” than initially expected earlier this year. Inflation remained above expectations in the first quarter, printing at 10.2%. The labor market remains tight but has "started to loosen." Committee members continue to monitor inflation and will adjust policy to bring inflation down to their 2% target, which they forecast could be reached in the "two- and three-year horizons."

 
 
DISPLAY 1
 
Monthly Interest Rate Summary
 

Source: Bloomberg

 
 
DISPLAY 2
 
MSILF Weighted Average Maturities (WAM) Summary2
 

Source: iMoneyNet

 
 

PORTFOLIO STRATEGY

Government/Treasury Strategy
Debt ceiling considerations continued to escalate through May, and this was the overriding macro factor for numerous asset classes. From a money market fund standpoint, Treasury bills maturing in early June were avoided, and some of these bills traded as high as 7% in late May. Thankfully, as the month came to an end, progress was made on a debt ceiling bill, relieving some of these tensions.

Auctions in May were volatile, as in-scope dates for the debt ceiling crept into tenors that most money funds frequent. This caused massive volatility through the month in a variety of auctions, and also contributed to the Treasury’s use of a number of cash management bills to bridge the gap. Money funds were more guarded and date-specific on supply they were willing to take down, and they generally stayed very defensive as debt ceiling tensions escalated. From a liquidity perspective, during peak debt-ceiling tensions, specific dates were wider than others, but broadly speaking T-bill liquidity was suitable.

Similar to April, elevated volatility allowed us to incrementally add callable agency debt across our Government portfolios, maintaining our duration along with our peers into the high-teens to low-20s. Against these purchases, we opportunistically sold some short-dated floating-rate notes and agency discount notes. In our Treasury Securities portfolio, debt ceiling concerns caused us to operate with a longer bias, as we avoided June/July/ August dates in favor of a barbell approach and awaited more information.

We expect the Fed to be nearing the end of its hiking cycle as officials are unwilling to change its stance until tangible evidence is seen in the jobs market or inflation data. Although the debate for a "pause" in the hiking cycle has intensified, recent Fed speak has indicated much of the committee remains concerned with the elevated levels in inflation and suppressed unemployment. Future decisions will become increasingly data-dependent.

Prime Strategy3
Weighted average maturity (WAM) and weighted average life (WAL) decreased intra-month as we allowed the portfolios to organically roll down while also actively raising liquidity to prepare for any debt ceiling volatility. Strong economic data and hawkish Fed comments continued to push expectations for interest rate cuts out of 2023 and increase the likelihood of a June rate increase, putting pressure on short-end rates, leaving us in a more opportune position to deploy the excess liquidity we have accumulated.

Following strong economic data releases and hawkish Fed rhetoric the past couple weeks, as of month-end, anticipated Fed pricing is much more in line with our expectations for the path of monetary policy throughout the remainder of the year, making us comfortable purchasing both fixed- and floating-rate securities across the money market curve. We continue to like floating-rate notes with 2023 end dates because they offer downside mitigation 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 in all likelihood the Fed is done raising rates and the next move is lower.

Liquidity remains strong and dealer balance sheets remain unconstrained as spreads have held mostly static 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 Strategy3
Short-term municipal rates continued to experience some volatility over the month of May. The SIFMA Index,4 which measures yields for weekly variable rate demand obligations (VRDOs), closed the month at 3.56%, lower than April but more attractive versus mid-month levels when dealer VRDO inventories were tight.

Yields at the longer end of the municipal money market maturity range rose during May in reaction to dislocations in the front end of the Treasury curve related to debt ceiling risks and concerns.

The WAM on the portfolio increased as a result of better fixed-rate opportunities and in anticipation of upcoming strong seasonal technicals. The portfolio took advantage of the inversion of the Bloomberg Municipal AAA Callable Curve5 by investing in high grade, 5% coupon, fixed maturities in early 2024.

Lingering uncertainty around Fed moves pitted against a strong summer reinvestment period with low expected issuance will determine municipal market performance and yield moves for the foreseeable future.

 
 

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.
5 Bloomberg BVAL Municipal AAA Callable Curve: BVAL Municipal AAA Benchmark Bloomberg’s evaluated pricing service, BVAL, provides a municipal "AAA" 5% coupon benchmark yield curve that is the baseline curve for BVAL tax-exempt municipals. It is populated with high quality US municipal bonds with an average rating of "AAA" from Moody’s and S&P. The yield curve is built using non-parametric fit of market data obtained from the Municipal Securities Rulemaking Board, new issues calendars, and other proprietary contributed prices. The benchmark is updated hourly and utilizes eligible "AAA" traded observations throughout the day and accessible on through Bloomberg services.

The views and opinions expressed are those of the Portfolio Management team as of May 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%

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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