November 19, 2021
November 19, 2021
Federal Reserve Board1
The Federal Open Market Committee (FOMC) voted unanimously to keep the range for 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. The committee believes that, since last December the benchmark of “substantial further progress” toward their goals of higher inflation and full employment has been met. 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 not on a pre-set course saying, “it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.”
The Fed believes economic conditions continue to “strengthen,” however, notes COVID-19 cases slowed the pace of the recovery in the third quarter. In addition to its quantitative easing and policy changes, the FOMC updated its language around inflation. The Fed now believes that inflation is “expected to be transitory.” The FOMC is optimistic that inflation pressures will abate saying, “progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation.”
European Central Bank1
At the European Central Bank’s (ECB) policy meeting on October 28, President Lagarde and the policy committee left the ECB deposit rate unchanged at -0.50%, as expected, and kept the size of the pandemic emergency purchase program (PEPP) and asset purchase program unchanged. The ECB continued to make purchases at a slower rate under the PEPP in response to elevated inflation levels, while downplaying the possibility of a rate hike in 2022. The Governing Council feels strongly that current policy is appropriate; however, if the outlook were to change the ECB “stands ready to adjust all of its instruments.”
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 surprised many as the MPC was expected to be first major central bank to shift interest rates higher since the pandemic started. The press release noted that “near-term uncertainties remain, especially around the outlook,” which likely factored into the BoE’s inaction. Moving forward, the MPC says, “it will be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.” Market participants— many of whom believed the first rate hike would occur in November—now project it to be in December.
Minutes from the September FOMC meeting highlighted plans to begin reducing the Fed’s bond-buying program, which was purchasing $120 billion monthly in Treasury and mortgage securities. Projections also showed that half of the officials expected that the economy would require at least one interest rate hike by the end of 2022. Progressing through the month, market participants began pricing in a more aggressive Fed stance in 2022, with futures ending the month expecting a full rate hike by the July 2022 FOMC meeting and another in the fourth quarter of 2022. As a result of these changing market expectations for the path of monetary policy in 2022, new issue offers in the commercial paper/ certificates of deposit space in the 9- to 13-month tenors widened, with 1-year LIBOR4 beginning the month at 0.23% and ending at 0.37%. 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 dates. Our portfolios ended the month with both WAM (weighted average maturity) and WAL (weighted average life) on the lower end of the peer group, with weekly liquidity hovering near 60%.
On October 7, the U.S. government raised the borrowing limit by $480 billion to $28.9 trillion and extended the debt ceiling date to December 3. This came after a protracted standoff in Washington and served as a very short-term solution. Yields on Treasuries maturing in December rose by several basis points right after the news was released; however, the hard debt limit date (“X date”) could be after December 3. Most market participants estimate the X date to be several weeks after December 3 given the U.S. Treasury’s ability to use extraordinary measures again and drawdown growing cash balances and incoming cash from budget line items. At this point, it is too soon to accurately predict the X date, but some estimate it to extend into early next year. While Washington could solve the debt limit issue legislatively before December, we continue to navigate the potential risks and outcomes as developments unfold. The U.S. Treasury was able to issue more bill supply after the borrowing limit increase, and we selectively bought Treasury bills for the portfolios. The large amount of cash in the front end muted most of the bill yield increases derived from the additional supply, as evidenced by the continued high volume done at the reverse repo facility this month (between $1.3 trillion and $1.4 trillion). 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 issuers took advantage of the low rate, high-demand environment in October to come to market ahead of election week and the uncertainty and volatility that will follow. The month saw over $65 billion of volume come into the market. The SIFMA Index,6 which measures yields for weekly variable rate demand obligations (VRDOs), was little changed over the course of the month, rising just 0.01% to 0.12%. Yields at the longer end of the municipal money market maturity range were little changed during the month as well, with investors digesting a significant pickup in the pace of new debt sales in October. A lack of clarity around fiscal aid exacerbated broader market volatility during the month. In the period ahead, we will watch to see how monetary policy unfolds and determine what impact the election results may have on municipal yields. We maintain a short duration stance given stretched valuations and the potential for increased volatility in the coming months.