Month in Cash: Finally able to catch our breath

05-01-2017

Political brinkmanship dominated the news cycle and impacted stocks and bonds in April, but it was in many ways the first calm month in some time for cash managers. After two Federal Reserve rate hikes in three months, the aftermath of money market fund reform and the always interesting year-end and quarter-end, it seemed even the occasional April shower was gentle and warm.

Domestic growth slowed a bit over the month, but the U.S. economy clearly remains on a positive and upward path. The housing market remains robust, retail sales are decent and manufacturing is hanging onto its recent resurgence. The disappointing employment report that showed the economy added only 98,000 nonfarm jobs in March likely is an aberration, especially as other measures of labor-market health remain strong. Inflation is still below the level the Fed would like to see, at least according to the personal consumption expenditures index, but it appears to be high enough to keep the Fed on track for two more moves in 2017. While policymakers do meet in May, the market and we here at Federated expect the hikes to come at the June and September meetings. The market isn’t completely buying a June hike, but it is the majority opinion at the moment, and the London interbank offered rate (Libor) has been inching up in anticipation.

Although the Fed has begun to discuss its humongous balance sheet, we feel any action this year to reduce their holdings of government and agency securities would come in the fourth quarter and be set up by plenty of Fedspeak far ahead of time.

With the military strike on Syria, talk of a federal government shutdown, the Trump administration’s controversial proposed tax cuts, a snap election in the U.K., belligerent talk by North Korea and unpredictable shifts in President Trump’s positions (including the possibility now that he might want Janet Yellen to chair the Fed for another term!), April had plenty of volatility. And that list does not even include the most potential market-moving event: the outcome of the French election.

It’s enough to make your head spin, but the Treasury yield curve has had none of that, flattening over April. That led us in the middle of month to shorten our weighted average maturity (WAM) by five days for our prime funds, bringing it in line with our government funds’ WAM of 35-45 days and closer to the target WAM of 30-40 days for our municipal money market funds. There was simply no reason to go further out the curve as relative value just wasn’t there and spreads had tightened. We still think floaters are attractive, though not as much as in the first quarter of this year. Our purchases of fixed-rate paper in April were on the short side, as well, mostly in the 2- and 3-month space. We would rather keep some dry powder for when the curve steepens. And we hope it would be due to the economy, not politics.

One final point: assets are slowly flowing back into institutional prime funds after the exodus that took place due to the reform in late 2016. From an industry perspective, total prime assets under management grew 5.8% in the first-quarter, according to iMoneyNet. Because of the relatively small asset base, the equivalent dollar growth of only $21 billion is not terribly impressive. But the inflows show that more institutional investors are now considering prime’s potential yield advantage over government funds and bank deposits.