Month in Cash: If Fed talks up March, it had best act

03-01-2017

Things are getting interesting for interest rates.

After the Federal Reserve telegraphed a hike before its December meeting and then rendered a move in early February highly unlikely, we are now back to the general uncertainty about policymakers’ thoughts that has dominated the last half decade. While it’s clear the Fed is close to its next hike, when it will come is anything but.

So, cash managers are back to trying to parse words, such as the insertion of “fairly soon” in the minutes from the February meeting to describe the next increase, or Chair Janet Yellen’s talk-but-say-little testimony to Congress. But she has sounded a touch more hawkish as of late. Is she attempting to jawbone us into thinking the Fed could raise rates at this month's meeting, after all? The market certainly is considering it. If so, she must be careful. There are many speeches by Fed officials in the upcoming days, before their radio silence prior to the start of every Federal Open Market Committee (FOMC) meeting. If these comments lead the markets to believe in a March move, and then the Fed doesn’t make one, it better be because the February employment report tanked or some other disruptive event occurred. If it stays pat for no apparent reason, the Fed will lose all credibility.

But there is another potential twist: May. If nothing else, the Fed loves tradition. Whether it is Fedspeak that is only understood in the context of the past, or those many unwritten rules such as not adjusting rates when it could affect an election, convention means a great deal to the central bank. One longstanding custom was that it did not communicate much with the public. Former Chair Ben Bernanke bucked tradition by adopting press conferences at every other FOMC meeting, with the understanding that major policy action would not occur in one of the other meetings. Recently, however, Yellen announced that the Fed had arranged for a conference call for those, effectively making all of the meetings “live.” All of this is to say that, if the Fed doesn’t hike in March, May could now be in play, instead of just moving expectations straight to June. This is especially the case if the March meeting’s statement or her press conference reveal that the decision to forgo a hike was a close one.

The self-professed data-dependent Fed certainly has positive economic reports to point to. Consumers have found confidence, manufacturing has found its footing and employers can’t find enough workers. Even stubborn inflation is starting to pick up, with some measures inching above the Fed’s 2% goal and some nearly at it. The performance and health of the economy may force Yellen’s hand.

As you might expect, cash managers are reacting differently to the uncertainty, one complicated by the fact that the London interbank offered rate (Libor) has been ticking up while spreads have been ticking down. In the middle of February, we decided to bring in our target range for our weighted average maturity (WAM) from 40-50 days to 35-45 for our government funds. We wanted to have more dry powder for what we think will be attractive floating-rate paper coming into the marketplace. We have not yet lowered the WAM range for our prime funds mainly because we are still of the opinion that prime securities have enough relative value to compensate for the extra days. In a rising-rate environment, shortening WAM not only captures extra yield potential, but also helps to stabilize funds. If only we got a stable sign from the Fed.