Month in Cash: Numbers game at the Fed

09-01-2018

Even the Federal Reserve’s “gradual” path of rate normalization beats the excruciatingly sluggish pace of the current confirmation process of new governors. At the end of August, Congress finally confirmed Richard Clarida as vice chair. About time, especially for this important position. But that leaves only four of seven board members in place. The governors still are outnumbered on the policymaking Federal Open Market Committee (FOMC) by the regional bank presidents, who have five seats filled on 1-year rotating basis.

If you wonder why I bring up the Fed’s roster frequently, it is because there are significant differences between the two groups. While the regional presidents are policy experts, they speak for their districts, and Atlanta has different issues than Minneapolis, which has different issues than San Francisco, and so forth. Each district reflects its own demographics. The regional banks also have different reports for which they are responsible, taking up time and resources.

In contrast, Fed board governors consider the impact of monetary policy from a national and global perspective. They take into consideration large-scale factors such as federal fiscal policy. They are able to think about and research monetary policy full-time. With the exception of the New York Fed president, who operates more like a governor due to the importance of that bank, regional Fed presidents don’t interact with the international community or regularly meet with other central bankers. Board governors represent the U.S. in world affairs, and we need a full complement.

The more pressing Fed issue is this month's FOMC meeting. The markets think there is more than a 90% chance of a 25-basis-point hike, with a little over 60% likelihood of another in December. So, the market is expecting continued increases which, at 2.25-2.50% at the end of this year, would take us close to the Fed’s neutral target of 2.9%. The markets still don’t know what will happen with the balance sheet in 2019. There has been no guidance yet on that, which is frustrating. I expected some two meetings ago.

The weighted average maturity (WAM) of our government funds was very short in August. It was simply due to the relative attractiveness of yields on short-term instruments. Why go out the curve when you can get the same rate with less duration. We think the market wasn’t pricing in a September move adequately until the last week of the month.

Speaking of new issuance, early last month we jumped on the chance to participate in the first sale of a security tied to the new Secured Overnight Financing Rate (SOFR) index, the one most likely to replace the London interbank offered rate (Libor). These were Fannie Mae instruments. Then in mid-August, our prime funds purchased asset-backed and financial commercial paper floaters priced with SOFR. Their spreads above overnight yields were attractive; it pays to be an early adopter.

The WAM ranges for our funds were: 25-35 days for government, 25-35 for municipal and 30-40 for prime. Libor was essentially unchanged over the month, with 1-month at 2.08%, 3-month at 2.32% and 6-month at 2.53%.