The Fed catches its breath
After four months of intense scrutiny, falling rates and turbulence, Federal Reserve officials are taking a breather. “Patience” isn’t back in its policy statement since being dropped in June, but its spirit has returned.
Although policymakers lowered the target range of the federal funds rate a quarter point to 1.50-1.75% at Wednesday's Federal Open Market Committee (FOMC) meeting, they want to observe the path of economic data before making the next step. Actually, there may not be a next step, up or down, for some time. They may find they have reached the neutral rate and can sit for a while. In any case, it is good news for cash managers and investors in the liquidity space that rates might hold steady for a while.
A pause also will give the Fed more time to investigate the dislocations in the overnight market that took place in September. That's when repo rates surprisingly spiked, and the Fed had to carry out daily and term operations. It eventually announced it will purchase Treasury bills on a monthly basis through at least the second quarter of 2020. As Fed analysts uncover why banks held back from financing their Treasury securities through the repo market in September, they face a new twist. Public interest in this obscure part the financial system also has spiked. This is the last thing the Fed wanted. “Mom and Pop” investors who never heard of the repo market are now worried about it, and Fed Chair Jerome Powell fielded questions about it in his FOMC press conference.
We think the Fed has made the correct policy response for now. But we also know policymakers don’t like trading in the overnight market on a daily basis. They must come up with some sort of a repo facility. To do so they will have to answer important questions: Who should have access to it and at what rate? Should they ease regulations to allow liquidity to flow easier? Should they automatically commit to daily operations at known times of stress, such as month- and quarter-end? There are no easy answers, and it will take time to figure it all out. Just as crucially, they must remove the stigma of using it.
Let’s now step out of the weeds to talk about a bigger—and positive—picture. Left for dead after money market reform, prime money funds across the industry have now had 12 months of solid inflows. It started when the tumbling equity markets got investors thinking about money funds again, and it grew as they valued the attractive spread. Government money funds also flourished, and municipals continued to offer good taxable-equivalent yields.
As for purchases in October, we found value in the 3-month area of both the London interbank offered rate (Libor) and Treasury yield curves. We shifted the weighted average maturity (WAM) of our govie funds out five days to a range of 35-45 days to capture the latter. Prime and muni WAMs remained in a target range of 40-50 days.