One Fed, two jobs
The Federal Reserve’s dual function as regulator and policy-setter has been on display.
When you hear talk of the two functions of the Federal Reserve, you likely think of its so-called “dual mandate” to foster maximum employment and stable prices. But that’s the goal of its monetary policy. The Fed’s foundational duality is actually to promote both those goals and the stability of the U.S. financial system. The Fed officially states it performs five functions. But one concerns setting policy while the other four fall under the rubric of safety.
This distinction is crucial to understanding the Fed’s decision-making following the collapse of Silicon Valley Bank (SVB). On the one hand, it acted swiftly to provide a safety net to the banking sector with the establishment of the Bank Term Funding Program. On the other hand, a week or so later, its Federal Open Market Committee (FOMC) voted to raise the federal funds rate by 25 basis points.
This might seem contradictory. Although much of SVB’s downfall stemmed from an overly concentrated clientele, a classic asset/liability mismatch and other mismanagement, the Fed’s aggressive tightening put the bank’s holdings of longer-term Treasuries underwater. From this perspective, the Fed perhaps should have foregone a hike. Yet its policy arm essentially shrugged this off. Not just because FOMC officials professed—and likely believed—that risks of contagion spreading to the broader banking system were minute, but because their focus remains on fighting inflation. Of course, Chair Jerome Powell had to address both issues, but he passed the buck on SVB to Vice Chair for Supervision Michael Barr.
The distinction is a major reason we think the FOMC won’t shift its foot from the gas to the brake pedal this year. Its members continually show they are willing to deal out pain in the name of restoring price stability. They’ve admittedly targeted increasing unemployment and tightening financial conditions—an agenda almost guaranteed to break some aspect of the financial system. We forecast another quarter-point hike at the May meeting and no cuts this year. That’s what the Summary of Economic Projections show, and betting against the Fed now is unwise. The markets keep flirting with making that bet, 50/50 on a hike in May and still pricing in a pivot this year. But expectations are volatile, and the debt ceiling X date looms. Unsurprisingly, there’s been little movement on that front.
It’s not surprising that customers spooked by the foundering of SVB have been transferring deposits from regional and smaller banks to larger ones. But we speculate this is only partly due to credit concerns. To the extent the situation prompted clients at all banks to take a close look at their account details, they likely realized those interest rates considerably lag that of most liquidity products, such as investor pools and money market funds. It’s been a bonanza for the latter across the liquidity investment industry. Total U.S. money fund assets increased by around $340 billion in March, among the largest inflows in history. As of March 28, they have reached a record $5.13 trillion (iMoneyNet). It seems the bank stress has woken the proverbial sleeping dog.
The target Weighted Average Maturity range of our money funds is 20-30 days for prime and 25-35 days for government and municipal.