Month in Cash: Don't confuse Powell's optimism with hawkishness

03-01-2018

The Jerome Powell era at the Federal Reserve essentially began this week with the new chairman’s high-profile testimony before Congress. You could, for the sake of brevity, summarize the entire event with that sentence. He didn’t offer any opinion or statement that was unexpected or materially different than the Fed’s outlook under Janet Yellen. But the risk markets had a sour reaction to his enthusiasm about the improvement of the U.S. economy since December, which caused a stir. We think it was an overreaction. Powell’s optimism might have been slightly…somewhat…a tad…a touch too strongly articulated, but Yellen probably wouldn’t had gotten any such response if she had said the same. We pin it on the uncertainty that comes with any change in leadership. Powell is no Yellen clone, but it will take more than one week to bring the differences to the fore.

It is no surprise, however, that his optimism nudged the fed funds futures market to expect four 25 basis-point moves this year instead of three. Likely many in the faction who shifted were already on the fence and tax reform pushed them over. We, of course, think the tax changes are a positive from a corporate perspective, but are just not as convinced the rewards will be reaped early enough to push up still stubbornly low inflation right off. The Fed’s (still) preferred metric of personal consumption expenditure (PCE) remains below its 2% target.

A lot depends on what companies do with the savings—they are just starting to reveal plans and the effects won’t show up right away. Even passing on some of the tax relief to employees through bonuses, raises, increasing 401(k) contributions and the like doesn’t mean inflation will flare. We want to see how this plays out a little bit more before changing our house call of three hikes in 2018, which we have held since the fourth quarter of 2017, although we could certainly see four. (By the way, the pace of hikes is at issue here, not the amount—don’t expect to see a half-point jump).

In the end, what matters the most from a cash manager perspective is always the next opportunity for a rate increase, and it is a virtual lock now that policymakers will raise the range from 1.25-1.50% to 1.50-1.75% at the Federal Open Market Committee meeting at the end of this month. Short rates are higher but the glut of government issuance this month also is playing a role, as the Treasury scrambles to fund the additions to the national debt that tax cuts and budget proposals likely will create. The London interbank offered rate (Libor), which Powell took the time to admonish everyone to abandon asap, has priced in most of the March move, with 1-month rising from 1.57% to 1.65%, 3-month from 1.77% to 1.99% and 6-month from 1.97% to 2.20%. Therefore, nothing has altered our preference for shorter-dated paper and variable-rate instruments as rates rise. All of our funds’ weighted average maturity (WAM) remain at 30-40 days (our prime call went to 30-40 from 40-50 in December), with weighted average life (WAL) pushing up against their maximums.