2020 Outlook: Optimism and opportunities 2020 Outlook: Optimism and opportunities http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\sunrise-lake-small.jpg February 21 2020 January 2 2020

2020 Outlook: Optimism and opportunities

The liquidity space should continue to grow in popularity in 2020.
Published January 2 2020
My Content

The stereotype of trading in the liquidity markets is that it’s a ho-hum job. No battling for deals like those in a stock exchange; just grab whatever offer that comes along. Well, not only is that unconditionally wrong, 2020 might force traders for money markets and the like to be as fierce as those in any sector.

With the Federal Reserve on hold, the yield curve relatively flat and the economy on a low-growth path, liquidity-market firms will contest for every basis point they can get. Relative outperformance will go to those best at identifying situations that can lead to an advantage. There will be periods when the yield curve offers a little more value, giving portfolio managers, analysts and traders opportunity to set them apart. I don’t get to talk about our traders often enough. With an average of 16 years of experience and a variety of expertise, I have the utmost confidence in them.

Key to this is how much money flows into the sector. Perhaps it won’t rise to the level of the tremendous growth of 2019, especially in the prime space, but liquidity products should experience solid inflows. We anticipate growth in the low double digits. There are plenty of people who are uncomfortable about the ebullience of the equity market right now or foresee volatility stemming from the presidential election. If they want to take some of their winnings off the table, the liquidity markets can provide a good home for them. In the current environment, they can offer a competitive return. In this regard, 2020 should see liquidity products taking their traditional role of being an asset class that works in tandem with the equity and fixed-income portions of an investor’s portfolio.

No repo drama but work to do

The Fed was able to ward off volatility in the repo market in the days spanning year-end. Some market participants were concerned rates might spike as they did in September. But through overnight and term operations, the Fed made almost $500 billion available to primary dealers on Dec. 31. This move proved successful—dealers took down roughly half of it—and repo rates traded well within the federal funds target range. 

But policymakers have much more work to do. They would like to avoid intervening daily and even periodically on stress dates such as corporate tax deadlines or quarter-ends and they have established that increasing bank reserves is the most effective means. We think the target is $1.5 trillion in reserves. The Fed should reach that level in spring of 2020. Then policymakers have to make some more decisions.

Will they back away from being such a major force in the marketplace? Will they continue to cut back on Treasury bill purchases? Would they just end the program or pare the amount from $60 billion a month to $50 billion to $40 billion? I don’t think the Fed has worked out the plan yet. Obviously the decision will have enormous consequences for cash managers, especially on the level of supply.

But we are optimistic about 2020, and frankly can’t wait to do our best work for clients. We extended that to our purchasing strategy for December, which focused on asset-back securities, bank instruments, government securities, commercial paper, Treasuries and more. The target weighted average maturity (WAM) of our funds remained in a range of 35-45 days for government and 40-50 days for prime and municipal.

Tags Liquidity . Monetary Policy . Interest Rates .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

Past performance is no guarantee of future results.

Federated Investment Management Company

1729275948