Month in Cash: Yellen's lecture in the mountains

09-01-2017

Janet Yellen picked a poor time for a history lesson, and for slapping herself and the Federal Reserve on the back.

As uncertainty and rhetoric about the federal budget and the debt ceiling were building, the Fed Chair used her elevated platform at late August’s Jackson Hole, Wyo., global central-bank symposium to look to the past. She tried to make the case that the Fed’s actions during and after the financial crisis, especially its new regulations, strengthened the banking system without clipping the economy’s wings. She warned about the potential dangers of undoing these rules. That seemed directed to President Trump, who is no fan of regulation. In fact, many assumed this speech surely means Trump will not nominate her for a second term.

We know Yellen always will be an academic at heart—this is not the first time she has taken that role in her tenure—and we realize she deeply believes the Fed’s post-crisis policy and intervention made a difference. In particular, she asserts that the largest banks are now much more creditworthy, resilient and liquid. But with the talk of a government shutdown (who knows if it will happen) and the Treasury defaulting (not a chance), she could have provided the markets and investors with some stability. At the very least she should have offered information about late September’s Federal Open Market Committee (FOMC) meeting, even if she only more-or-less confirmed the Fed will begin to unwind its massive balance sheet then.

So we must go back to July’s meeting minutes and to recent speeches by other Fed officials to glean what might happen. They seemed to point to the FOMC addressing the balance sheet in September and tightening in December. But the markets are not believing the latter right now, pricing in far less than 50% of a hike happening by year-end. In fact, it is not until June of 2018 that there is full expectation of another move. There are no market-based odds on the balance-sheet reduction, but we think it will happen. It will be the Fed’s way of saying it is still committed to policy normalization.

Returning to the debt ceiling, which is more crucial to cash managers than the budget debate, we will address this in detail in a separate commentary. But the short version is that, while we believe there is zero percent chance of a default, technical or otherwise, we are avoiding Treasuries maturing around early October when the Treasury will exhaust its extraordinary measures.

The London interbank offered rate (Libor) continues to be stable, reflecting that the next Fed move won’t happen this year. Our weighted average maturity remains at 30-40 days for our government and municipal products, and 40-50 days for our prime products, with most sitting in the middle of these target ranges. We continue to buy floaters as we see them in attractive form. But even in this time of Libor stasis, it is important to remember that we are still in a rising-rate environment and, industry-wide, prime funds remain more responsive than bank deposit rates because they trace increasing rates better on a historical basis. More than ever, the rallying call for cash managers is that the time is ripe for moving into, or back into, the typically higher-yielding prime funds.