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August 25, 2023

Policy Rates Move Higher Again

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August 25, 2023

Policy Rates Move Higher Again


Market Insights

Policy Rates Move Higher Again

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August 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 5.25% to 5.50% at the conclusion of its July meeting. The accompanying press release included an upgrade to its characterization of economic growth from “modest” to “moderate,” but the statement overall was mostly unchanged. The job market remains strong, and inflation continues to run above the Federal Reserve’s (Fed) target. In his press conference, Chair Powell explained that the Fed remains data-dependent going forward while market participants grapple with the validity of another hike later in year.

European Central Bank1
At the European Central Bank’s (ECB) policy meeting on July 27, President Lagarde and the policy committee increased the ECB deposit rate by 0.25% to 3.75%. The ECB is maintaining its data-dependent approach and is committed to bringing down inflation. The committee believes the rate hikes are having an impact and sees inflation declining the rest of the year but remaining above its 2% target.

Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 6-3 to increase the Bank Rate by 0.25% to 5.25% at its August meeting. Two dissenting members preferred to increase the rate 0.50% to 5.50% while the remaining dissenting member preferred to keep the rate unchanged at 5.00%. The June 12-month inflation data came in below expectations at 7.9%. While labor markets remain “tight,” MPC members noted that it is starting to show signs of “loosening.” The BoE forecasts consumer price index inflation to end 2023 around 5.0%, then ultimately falling to the 2% target by the second quarter of 2025. The committee remains committed to reducing inflation and “will ensure that Bank Rate is sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably.”

 
 
 
Display 1: Monthly Interest Rate Summary as of 7/31/23.
 

Source: Bloomberg

 
 
 
Display 2: MSILF Weighted Average Maturities (WAM) Summary as of 7/31/23.2
 

Source: iMoneyNet 

 
 

PORTFOLIO STRATEGY

Government/Treasury Strategy

We added 3- and 6-month Treasury bills across the portfolios intra-month to bring WAMs to the mid-20s and in line with our competitors. Fed sentiment has begun to shift, and although it’s not yet clear if the Fed is done hiking, the likelihood that we are approaching the end of the cycle is rising, making some fixed-rate investments more appealing. Additionally, we added Treasury floating-rate note exposure, where applicable, to seek to benefit from the Fed’s likely higher-for-longer path coupled with the continued increases in bill supply.

The Fed is highly data dependent—torn between improving inflation data and a very strong jobs market. We feel the Fed is being cautious about a resurgence of inflation and will likely find a way to raise rates gently from here. However, that pace does not need to be every meeting, and we could potentially see a few calibration hikes with longer pauses in between. Data will be closely watched as the next FOMC meeting is not until September.

Supply remains elevated, with issuance likely taking another leg higher in the back half of the year. So far this year, supply has been taken down quite well by the yield-seeking community of front-end investors. We will see how this develops as dealer balance sheets fill up with these larger chunks of issuance.

All eyes are on inflation and jobs data, both of which will indicate just how close the FOMC is to a holding pattern. We are certainly closer to the end of the hiking cycle, but inflation has shown in the past its ability to remain resilient, and a few more hikes at this point are still possible.

Prime Strategy3

After extending both weighted average maturity (WAM) and weighted average life (WAL) throughout the month of June, we allowed the portfolios to organically shorten this past month. With the futures market priced mostly in line with Fed projections, indicating a 40% chance of another rate hike by the November FOMC meeting and a hold thereafter, we continue to opportunistically add duration in the 5- to 6-month tenors when we feel the market is compensating it. We are also adding floating-rate notes with 2023 maturities that have coupons that will reset higher in the event the Fed raises rates sooner or reaches a peak rate higher than what the market anticipates.

The Fed continues to stress that it will remain data dependent and keep rates in restrictive territory until inflation returns to its 2% longer-run objective. We continue to use the June dot plot as our base case path for monetary policy, with one additional interest rate hike penciled in for the remainder of the year, before easing in 2024. With the futures market now pricing out all rate cuts in 2023—much more in line with Fed expectations—we remain comfortable purchasing both fixed- and floating-rate securities across the money market curve. We remain confident targeting floating-rate notes with 2023 maturity 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

The Bloomberg Municipal Short-Term Index4 posted a +0.26% return for the month of July 2023 as a result of strong July reinvestment flows amid muted supply.

The SIFMA Index,5 which measures yields for weekly variable rate demand obligations (VRDOs), closed the month at 3.98%, down 2 basis points versus June.

With the FOMC highly attentive to inflation risks, Treasury issuance estimated to exceed $1 trillion in the third quarter and higher municipal bond issuance projections in second half of the year, we allowed the WAM and WAL on the portfolio to roll down, in anticipation of higher VRDO rates.

 
 

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 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.

5 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 July 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%

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