2018 Outlook: Month in Cash

01-01-2018

This time of the year, the talk is always about resolutions. For cash managers in 2018, the better word is “resolute.” We think this year will continue to be a slow and steady march into 2% land, for both government rates and inflation. That’s a sunny path to be sure, but there’s potential for distractions. Looking unwaveringly past those as the year progresses will be important for money managers for setting investment strategy and in managing daily operations.

The Federal Reserve is, of course, at the center of it all. Its December Federal Open Market Committee (FOMC) meeting went as expected, resulting in a rate increase (to a range of 1.25-1.50%) and projections for three more in 2018. We think the moves will be front-loaded—happening in March, June and September—leaving open the potential for yet another one of those Fed year-end hikes. But whenever they come, three rate increases would put the short end of the London interbank offered rate (Libor) in a range of 2-2.25%.

Yes, you read that correctly. The cash markets could very well have a two handle this year! In fact, we already are seeing 12-month trades in that range. If our expectations of three moves rings true, 9-month trades could soon hit that 2% level, then 6-month trades, then 3-month trades, etc.

But as we all know, the Fed also can disrupt even its own plans, or at the very least create bumps in the road, and there will be opportunities this year. One is what the effect will be on the yield curve from the ever-increasing roll-off of the Fed’s mammoth balance sheet. If the Fed sticks to its schedule, it will be reducing reinvestments by $50 billion a month in the final quarter of 2018 and will have pared $450 billion from the start of the program in October. That’s a significant amount in total, but more importantly, the slow rise means supply will be in constant change. No matter how much the Fed assures us, no one knows exactly how the markets will react.

Another Fed issue is the number of empty seats on its board of governors. When the board is at full strength, the governors make up the majority of the policy-setting FOMC compared to the presidents of the regional Fed branches. At a time when many see little change between outgoing Chair Janet Yellen and her successor Jerome Powell, there is potential for risk in 2018 if we have four open posts out of a 12-member capacity, especially if New York Fed President William Dudley retires soon. As I have already expressed, monetary policy—particularly as policymakers head into the uncharted territory of tapering—should be navigated with a full crew.

But neither of these two points is likely to be a major issue, and we don’t expect much volatility as the year progresses, or much change at all from the environment of the latter half of 2017. The economy is gaining momentum, Libor remains supportive, floating-rate securities should still be attractive and prime funds industry-wide likely will see inflows because they tend to respond faster to rising rates than deposit products. So stay the course as it twists and turns, because it also likely will be rising.