Month in Cash: Same ol', same ol' and that's OK

06-01-2018

New developments in the cash market were hard to come by in May. The month seemed a continuation of the main topics of April. That’s not a bad thing; cash managers have had plenty to consider in recent quarters.

The Federal Reserve’s policy meeting in early May, and the minutes released later in the month, showed a central bank bent on keeping monetary policy in low gear, grinding on regardless of geopolitical events, market movement, trade-war talk or elections. The core personal consumption expenditures index (PCE) climbed ahead of the meeting, nearly hitting the Fed’s established goal of 2% inflation. But rather than be excited that this data, which the Fed looks to more than the consumer price index (CPI) for a measure of inflation, policymakers again suggested that they would permit it to overshoot that mark. As much as the Fed likes to tout itself as being data dependent, gut feeling and subjectivity still factor into its decisions.

The Fed took no rate action in May, but the content of the meeting statement suggested the next 25-basis-point hike likely will happen at the June meeting. The markets think it is a done deal, but are split between expecting one or two additional hikes the remainder of the year. We still expect a total of three in 2018, but will re-evaluate after parsing the June Federal Open Market Committee statement.

While the spread between the 3-month London interbank offered rate (Libor) and the overnight index swap (OIS) slightly narrowed compared to April, it remained elevated in May relative to normal. The reason for the elevated spread remains the same: it’s not driven by poor bank credit, the economic and political predicament transpiring in Italy or the potential summit with North Korea. Rather it is again due to the atypical large quantities of Treasuries the U.S. has had to issue to fund itself amid lower tax revenue and higher spending. We expect to see T-bill issuance ramp up to April levels early in the third quarter. Combined with even more securities rolling off the Fed balance sheet ($40 billion monthly by then), the excess supply likely will push yields higher. Cash managers are certainly not complaining.

If you allow a little inside baseball, the minutes also show that the policymakers discussed the need to reduce the interest it pays banks on some of the money they stow at the Fed. The interest on excess reserves (IOER) rate has been high enough recently that it has discouraged banks from lending directly to consumers and businesses. The idea floated is to lower the spread of IOER over the low end of the federal funds target range, which also is the rate the Fed pays on its overnight reverse repo facility (RRP). For instance, if the Fed does hike rates to a range of 1.75-2% in June and went forward with this plan, it might position IOER at 1.95% rather than 2%.

While nothing compared to the volatility of the stock market in May, the relative fluctuation in the short end of the Treasury curve led us to shorten the weighted average maturity (WAM) of our government funds by five days to a range of 25-35 days. The range for our prime and muni funds remained 30-40 days. We continued to purchase Treasuries because of their still attractive yields on elevated supply. The short end of the Libor curve ended May in a holding pattern ahead of a likely June hike: 1-month Libor increased from 1.91% to 1.98%; 3-month decreased from 2.36% to 2.31%; and 6-month slipped from 2.52% to 2.47%.