Month in Cash: Stay the course

02-01-2018

For an entity whose leader has essentially been let go (“You’re fired”) by the new boss, the Federal Reserve (Fed) is expected to have a smooth transition from Chair Janet Yellen to incoming head Jerome Powell. Down the road, Powell undoubtedly will put his stamp on policy, and probably financial regulation, as well. But in the short term, the shift should be like a copilot taking the controls when the pilot needs a break.

Of course, that doesn’t happen when the airplane is fighting turbulence. Powell, whose first work day as chairman is this Monday, benefits from an improving domestic economy and normalization policy that are going smoothly. We think he will rely on the central bank’s “data dependent” approach until he is more comfortable with the new position. After all, he has been on the Fed board for some time (2012) and has never dissented from the policy-setting Federal Open Market Committee (FOMC) statement under Yellen or former Chairman Ben Bernanke.

Given the amount of open seats on the FOMC—four now and five if New York Fed President William Dudley retires and the Senate doesn’t confirm Marvin Goodfriend—Powell might be best served letting the dot plot and other projections do the talking. That the tapering of the balance sheet has begun on a set path will help. The point here is that, in the short term, he has the luxury of a supportive structure in place for the transition and, frankly, that he should rely on it. Challenges are on the horizon, including the pace of rate hikes if inflation wakes up—or animal spirits rouse it—and the potential that wages finally take off. 

I didn’t mention the debt ceiling as a challenge because we have very few concerns that the government will allow a technical default. We have been down this path before. But that’s our strategic outlook; tactically, we are preparing for it by generally avoiding trades in the 4- to 6-week range unless they are slam dunks. Those still exist because the market has no consensus on exactly when the Treasury would run out of extraordinary measures and have to go to, well, even more extraordinary measures. As of now, there’s not been much pressure on any particular bills.

So we have kept our weighted average maturity (WAM) target range at 30-40 days for prime, government and municipal funds. Our holdings on the prime and govie sectors continued to buy floaters when they were attractively priced. Issuance was not a problem throughout the month of January, with plenty of floating-rate securities from banks, commercial paper issuers and government agencies. On the fixed-rate side, three months and under, we also found good value.

On the other side of the December 2017 rate hike, the 1-month London interbank offered rate (Libor) was static in January at 1.57%. But the 3-month area of the curve rose from 1.69% to 1.77% and the 6-month from 1.84% to 1.97%, both starting to anticipate the likely March hike.