Month in Cash: Pay attention to what the Fed does, not says


Last month, Fed Chair Janet Yellen put on her academic mortarboard and delivered a history lesson. Last week, she traded it for a Sherlock Holmes houndstooth hat for “The Case of the Missing Inflation”: “The shortfall in inflation is a mystery,” she said in a speech in Ohio.

She and other economists may be frustrated that things aren’t following their equations, but they seem to be pretty comfortable that inflation is either at or near enough to their target to keep tightening. In any case, cash managers tend to look at what Federal Reserve policymakers do, not what they say. With four rate hikes in the last two years, and a fifth likely coming in December, it would seem the Federal Open Market Committee (FOMC) participants think they won’t need a sleuth with a magnifying glass to find rising prices and wages.

If we needed another clue to their thinking, the Fed officially announced that in October—today, actually—it will begin to pare its massive balance sheet, a sign that extraordinary accommodation is coming to an end. All cash managers and nearly everyone else in the industry expected this move—it was just a matter of when it would happen—so there wasn’t a negative market reaction.

We can’t help but wondering if Yellen factored in her legacy with the start of tapering. With this, she will get credit for reversing nearly all of the post-recession monetary policies. But it also was just time to start normalization. The Fed is not comfortable holding such a large amount of assets, and if they didn’t start to reduce it soon, it would have begun to fester.

With only $10 billion rolled off each month, the taper is modest. Its main effect on money markets is operational, as it increases the supply of Treasury bills in the marketplace, which is a good thing. There won’t be any lack of demand for the extra supply, even as the amount increases in coming quarters.

Meanwhile, the Fed’s economic projections released at the last policy meeting suggest another 25 basis-point hike is on the table this year. We have thought so for some time now, and the market has returned to that opinion after doubting it recently. There will be some noise, both from the aftermath of the destructive hurricanes and the postponed debate over the federal budget and debt ceiling, but that shouldn’t make a major difference. We already have seen more value come back into the yield curve: a slight steepening that has made 3- and 6-month fixed-rate paper attractive along with floaters.

We have therefore kept the weighted average maturity (WAM) of our products at last month’s ranges: 40-50 days for prime and 30-40 days for government and municipal funds, with most lying in the middle of these target ranges. Industry-wide, prime products tend to more responsive than bank deposits to rising rates because they trade the London interbank offered rate (Libor), which historically responds to Fed hikes quicker. It is important to remember that money market funds provide a market rate, not an administrative one chosen by a bank or similar institution.