December 14, 2022
To Restrictive and Beyond
December 14, 2022
Federal Reserve Board1
At its November meeting, the Federal Reserve (Fed) increased its federal funds target rate by 0.75% at for the fourth consecutive time. The Fed continues to progress on its path to “sufficiently restrictive” policy, and there were several high-profile economic data releases of note throughout the month. Third quarter gross domestic product (GDP) exceeded expectations with an increase of 2.9% (annualized), and monthly non-farm payrolls also surpassed expectations. Speaking at the Brookings Institute at the end of November, Chair Powell said, “The time for moderating the pace of rate increases may come as soon as the December meeting.” The Federal Open Market Committee (FOMC) is paying close attention to the impacts of its policy as the economy starts to absorb 4.00% of interest rate hikes implemented so far this year. Market participants expect rates to increase by 0.50%* in December.
European Central Bank1
Although no formal policy meeting was held in November, analysts expect the European Central Bank (ECB) to hike rates in December. The ECB continues to wrestle with persistent inflation and demand as risks of a recession increase.
Bank of England1
The Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to increase the Bank Rate by 0.75% to 3.00% at its November meeting. Risks remain skewed to the upside in the near term as the Bank of England attempts to prevent inflation from becoming completely entrenched. The MPC expects GDP growth to decline as tighter financial conditions and elevated energy prices dampen spending. The BoE is committed to bringing inflation down and expects it to begin declining in mid-2023. The committee stands ready to act “forcefully” if the inflation becomes more ingrained.
The two main takeaways from the November FOMC meeting were that Chair Powell laid the foundation to downshift to a smaller 50 basis point rate hike at the upcoming December meeting and that officials expect the terminal rate to be higher than previously anticipated. As of November 30, the market was fully pricing in a 50 basis point rate hike in December and another 50 basis points worth of tightening in early 2023. While we remain comfortable with high allocations to SOFR (secured overnight financing rate) floating-rate notes and elevated levels of weekly liquidity, which contributes to our short duration profile, throughout the month we took opportunities to add duration to the portfolios, with our weighted average maturity (WAM) extending from 8 days to 15 days month-over-month.
At the November FOMC meeting, Chair Powell left the door open to reducing the pace of hikes at future meetings, but clarified it was premature to consider a “pause” in hikes. This meeting shifted the narrative in markets, from a rapid hiking slope to a measured one, albeit leading to a higher terminal rate. Although Fed speakers reinforced this posture during the month, the lower-than-expected inflation report caused markets to latch onto the pivot narrative and financial conditions eased significantly by the end of the month. Ahead of the blackout period, Fed officials closed November continuing to stress that inflation remains a major issue, and many in the market still forecast a terminal rate of 5% to 5.25% as a highly likely outcome.
November municipal bond issuance hit a 23-year low, as total volume for the month dipped below $20 billion. Issuance declined 47% year-over-year as issuers dealt with continued market volatility and uncertain Fed policy. As a result, municipal bonds saw the best performance in November in decades. The Bloomberg Municipal Index ended the month in the positive by 4.68%.
At the short end of the municipal curve, yields for variable rate demand obligations (VRDOs) decreased during the month, driven lower by a preference for shorter duration assets. The SIFMA Index,4 which measures yields for weekly VRDOs, declined 53 basis points to finish the month at 1.85%. Yields at the longer end of the municipal money market maturity range also fell over the course of the month. The Bloomberg BVAL One-Year Note Index5 decreased 56 basis points, finishing the month at 2.47%. We believe our portfolio is well positioned for a rising rate environment, maintaining a short duration with high concentrations in VRDOs.
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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