Month in Cash: Weather still freezing but economy thawing
A frigid January kept the money markets on ice, despite some mixed signals from the U.S. and world economies. The Federal Reserve’s decision to continue with tapering did not have a pronounced effect, as the commercial paper and cash markets held up well. Supply was pretty good without any hiccups, and the yield curve ended the month basically where it was at the end of December. We did see a flight to quality toward the end of the month on troubles in emerging-market countries as well as the Fed’s decision to reduce monthly asset purchases, known as quantitative easing (QE), another $10 billion to $65 billion, split between mortgage-backed securities and Treasury securities.
While this risk-off trade impacted the equity and bond market in the month’s final week, from a money-market perspective, the Fed’s decision to extend the experimental overnight reverse repo facility was more important and a positive. The Fed is testing the facility to help manage its an exit from extraordinary monetary accommodation of the past several years, and both our funds—which have utilized the facility to the tune of a couple billion dollars daily—and the broader market have benefitted. At the end of the December and into most of January, there would have been zero to potentially negative rates offered for some forms of repo had the Fed, through the facility, not improved supply and essentially set a floor on overnight rates. Supply and demand remains out of whack and continues to keep rates low, which is a key reason we welcome the Fed’s extension of the program.
The Fed raised the daily allotment cap to $5 billion per counterparty from $3 billion, which frankly doesn’t help us a whole lot since in general our funds haven’t used the tool up to the previous limit. Even so, there is no question that the facility’s reverse repo rates, which can go as high as 5 basis points, have been very helpful in nudging up rates or at the least preventing them from falling even lower. Now with the program’s extension, our attention is turning to the debt ceiling, which officially comes Feb. 7 but with cash on hand and other extraordinary measures at its disposal, the Treasury likely can make do by meeting all the country’s financial obligations through February and into early March.
Weathering the seasonal data
As far as the economy, you can’t blame the weather for everything, but it did continue to weigh on the housing market. This is about the worst time of the year to either start building a house or undertake a search for an existing house. U.S. housing starts and confidence slipped in December, with new construction falling 9.8% to 999,000 and sales of new homes dropping 7% to a seasonally adjusted annual rate of 414,000. We are not surprised by that. It is not as if the numbers have gone negative, they are just not as strong. But that dip, coupled with a weak jobs report, adds credence to why the Fed shaved QE by only another $10 billion rather than not accelerate the reduction of asset buying. And it also accounts for why it will not raise the benchmark funds rate for some time. Plus, all the single-digit temperatures we have been having during the month of January are going to wreak havoc with some of the economic data this month, too, so it may be a few months before we get a good handle on how the economy is doing.