Month in Cash: Hiking expectations for hikes

12-01-2016

November brought more than a few uncertainties to the fore following the election of Donald Trump, but we were surprised that many included a rate hike as one of them. At the time, we said that after Thanksgiving, cooler heads would prevail and that the market eventually would again start building in a December Federal Reserve move, one we remained quite bullish on. Turns out, it didn’t even take that long. The implied probability of the Fed raising rates jumped back even before the holiday. Fed futures are now nearly unanimous in expecting a 25 basis-point increase in the target fed funds range at this point. There would have to be a calamity in the world for this not to happen. Every Fed governor who has spoken publically, including Chair Yellen recently in front of Congress, has essentially said this.

We also expect the Dec. 14 Federal Open Market Committee (FOMC) meeting to raise expectations of future action. As you know, on several occasions in 2016 policymakers reduced their projections for the number of times they would raise rates this year and next. We think the improving U.S. economy and the likelihood for fiscal stimulus from the Trump administration, in whatever form it takes, will lead to higher growth, inflation and rates. This scenario won’t play out until at least mid-2017, but expectations are growing for three hikes instead of two. If the latter, it would probably be one in March and September. Cash managers’ main instruments, including Treasuries, agencies and commercial paper, already are beginning to price that in.

All of this, of course, is good news from a return perspective for money market funds. And it is important to keep in mind that total return is now the gauge of performance for institutional prime money market funds rather than just yield, which has the potential to change slightly because prime funds now float their shares’ net asset value (NAV).

On this subject, hardly a day goes by that someone doesn’t ask us if the Trump administration’s pledge to reduce regulation would apply to the reforms of Rule 2a-7 that forced a floating NAV. We don’t see it. The focus likely will be on changes that have not yet occurred, such as the recently announced Department of Labor fiduciary rule or some Dodd-Frank requirements not yet enacted.

What about the Fed? We doubt the leadership makeup will change midstream. Janet Yellen will be chair until her term ends in early 2018, although she probably won’t be re-elected. However, new FOMC voting members will come into play in 2017 that should turn what is a currently dovish membership to one more balanced and has some definite hawks in it. This would continue the theme of higher rates and a pro-growth, normalized inflation environment.

We continue to keep our target weighted average maturity (WAM) at 40-50 days, with most in the middle of that range. Government WAMs have been a little longer than prime funds, actually. This may seem a little long of a position in a rising-rate environment, but the yield curve is steep and offering such value. The London interbank offered rate (Libor) curve rose over the month of November: one-month Libor increased from 0.53% to 0.62%, three-month from 0.89% to 0.93% and six-month from 1.26% to 1.64%.