Month in Cash: The Fed repo man is on our side
Quantitative easing and zero-bound interest rates get all the attention when analysts and investors talk about the Federal Reserve. Certainly speeches in April by Chair Janet Yellen and the Federal Open Market Committee statement released at the conclusion of the FOMC meeting on the last day of the month affirmed that it will continue to base its policy decisions on a broader, more qualitative approach rather than anchoring actions to specific numbers of unemployment and inflation (although policy is still data dependent). But much can be read into its motives from an end-of-quantitative-easing perspective. When the FOMC announced in its recent meeting that it will taper the amount of monthly asset purchases on the open market down to $45 billion a month, it also signaled faith in an improving economy. So policy is steady as we go and that is where we will be for some time, although it looks like we are pulling out of the winter slump.
But for cash management, a lesser-known program has been just as big a factor as QE. The New York Fed’s Overnight Reverse Repo Facility—a relatively new Fed program that is aimed at giving the central bank better control over short-term rates—has kept money-market funds in a better position in 2014 than they probably could have been. The facility, first launched as an experiment and now afforded operation status, has helped to provide a floor to the market even in this time of exceptionally low rates.
The important number for us is not 45 but five, the number of basis points the New York Fed has offered to nontraditional participants over the last few months through the reverse repo facility. The Fed is still tinkering with this newest tool in its monetary-policy toolbox, potentially adjusting who the participants are, how much a participant can bid per day and what the rate will be.
All of these metrics have expanded or increased since the program began in experimental form several months ago, but April has finally seen some consistency with the Fed offering a return of five basis points throughout. April would have been a tale of two halves without it. Repo rates traded around six to seven basis points for the first half of the month, but could very well have plunged to near zero as a result of a notable pay down in Treasury bills in the second half were it not for the Fed’s five points. And the steady rate is helpful too, giving some certainty in what has been anything but a normative time for money markets.
Portfolio strategy longing for shorter weighted average
But the success of the Fed’s reverse repo of course doesn’t mean we aren’t still looking forward to real rate hikes. We still think a rise won’t materialize until 2015—although it is possible that the yield curve could anticipate that and steepen earlier—but positive economic reports show the consumer is back in action. And manufacturing and inflation ticking higher in April lead us to believe it won’t be long now. Having said that, it is always good to get a month or two of confirmation.
Until then our strategy remains on the long side, with a target of 45 to 55 days for our government portfolios and 40 to 50 days for our prime portfolios. We stand ready to shorten that range, as well as add more floating-rate securities, at the hint of rate increases.