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Return voyage

The new Fed chief must be careful not to rock the boat.
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Jerome Powell is not only the new chair of the Federal Reserve, he also essentially has a different job than its last two leaders. While Ben Bernanke had to bail water and Janet Yellen had to right the ship, Powell is charged with steering the economy back into harbor. In the statement and projections from last month’s Federal Open Market Committee () meeting, the first led by him, policymakers saw employment firming, inflation building—not ballooning—and economic activity increasing over the next few years. They seem to be dropping “cautiously” from “cautiously optimistic” about the next couple of years.

The aggressive actions the Fed took during and after the financial crisis will be debated in academic papers and opinion pages for decades, but with rates normalizing and the balance sheet declining (quantitative tapering is now up to $20 billion a month), monetary policy is getting more straightforward. In its place, however, is choppy water of a different sort, political and unpredictable: tariffs, taxes, walls, global relations, deficits and more. 

What the U.S. economy needs now is a Fed that provides stability amid the uncertainty. Keeping things steady will be difficult, but if Powell can do it with the calm, confident and concise communication he showed in the press conference (only 43 minutes long!), it would be a major accomplishment. This is not a gender issue—both Ben Bernanke and Janet Yellen spoke in a stiff, academic style that was sometimes off-putting. Powell so far has cut to the point in an almost casual way.

Of course, while his public persona is important, the real test will be if Powell can gather consensus within the Fed board—still largely unfilled—and with regional presidents. The FOMC vote to raise the fed funds target range from 1.25-1.50% to 1.50-1.75% was unanimous, but that isn’t likely to continue. If Chair Powell can maintain solidarity, he surely will have the chance to put his stamp on policy. But for now, we’ll take slow and steady.

For cash managers, it was particularly helpful that the March hike and the projections for two more this year and three in 2019 were in line with expectations because we have our hands full with the remarkable amount of short-term Treasury supply in the market. Ever since the suspension of the debt ceiling, the U.S. Treasury has been borrowing at an accelerated rate to fund increased government spending with less revenue from taxes and to build up a cash balance. In fact, short Treasury yields were so elevated that overnight repo rates didn’t rise much following the announcement of the hike because they already were nearly there.

Not that we, or anyone in the industry, is complaining; it’s a wonderful problem to have. Our trading floor has a lot more smiling faces than two years ago. In fact, the excess supply—furthered by the Fed’s balance sheet roll off—pushed yields so high they were attractive enough for portfolio managers around the country to add Treasuries to their prime products. Holding T-bills for liquidity is one thing; holding them for yield is another. It has been a long time, certainly before the crisis, since we have done that. Our prime products have benefitted from a spike in the London interbank offered rate (Libor), also due to the federal government tax overhaul (see sidebar). Libor's vault over the month had 1-month closing at 1.88%, from 1.65% at the end of February; 3-month at 2.31%, from 1.99%; and 6-month at 2.45%, from 2.20%.

Tax law hits cash spreads
There lately has been concern over the widening of spreads between the 3-month London interbank offered rate (Libor) and the Overnight Index Swap (). Historically, these spreads range between 10-20 basis points, but they are around 60 now. The last time spreads were this wide was during the European bank crisis of 2011. But this time is entirely different. It's not credit related, but rather due to the new tax code requiring U.S.-based companies to repatriate overseas cash. These companies traditionally buy Treasury bills, commercial paper and bank CDs with that money. Now, they have to bring it here and pay taxes. This has slashed the demand for short-term securities, driving up their yields and overnight funding spreads. While the Treasury issuance may pull back as tax receipts stream in after April 15, repatriation likely is going to play out over the entirety of 2018.

Tags Liquidity