Month in Cash: No more normal?

07-02-2018

For the Federal Reserve over the last 2½ years, business as normal has been the business of normalizing policy. It looks as if the Fed has finally shifted to tightening.

In mid-June, it raised rates to a target range of 1.75-2%, closer than the Fed has been in more than a decade to its comfort zone. With its summary of economic projections now indicating two more hikes in 2018 (our house call, as well) and three in 2019, quantitative tapering (QT) set to expand to $40 billion per month in July and Chair Jerome Powell’s upbeat assessment of the economy, it appears expansionary policy will soon run its course. We likely are near a bona-fide tightening cycle.

In addition to gushing about the economy, Powell announced that starting in July, he would be holding press conferences after every Federal Open Market Committee (FOMC) meeting instead of every other one. This is the culmination of years of trying to make the Fed’s decision-making transparent, a far cry from its tradition of keeping monetary policy a secret. Powell’s reasoning is that the markets have stopped even considering rate action in meetings when he doesn’t speak. That is true, but the extra pressers could result in occasional unintentional transmitting of information. Case in point: June's hike. While the committee simply indicated it expected to issue two more 25 basis-point increases this year, Powell painted that info a hawkish hue by using the word “great” to describe the economy when speaking to the press. As the Fed tightens, hikes will become more and more critical and Fedspeak more and more scrutinized because too many hikes might precipitate a recession. The "plain-spoken" Powell will need to choose his words carefully.

In June, the 1-month London interbank offered rate (Libor) rose from 1.98% to 2.09%; 3-month increased from 2.31% to 2.34%; and 6-month rose from 2.47% to 2.50%. The bump in the short end made floating-rate securities attractive for cash managers. The prime space saw a substantial supply of these and other short-term instruments, such as commercial and bank paper, and even Treasuries fit because of their still attractive yields on elevated supply. We kept the weighted average maturity (WAM) of our prime funds in a 30-40 day range, and at the short end of that for good measure. Our municipal WAM range dropped to 25-35 days, but our government funds remained within 25-35 days.

In June, institutional prime products industry-wide continued to show only minor net asset value (NAV) movement. This stability played a large part in investors returning cash to the sector, as the appeal of the additional 25-30 basis points in spread over government funds with next-to-no concern of loss of principal. Lastly, the spread between 3-month Libor and the Overnight Index Swap (OIS) remained wide in the month, not due to poor bank credit but excess short-term Treasury issuance from the Treasury Department and supply coming from Fed QT.