Opportunities across the yield curve Opportunities across the yield curve http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\webcasts\devils-bridge-small.jpg May 21 2021 April 21 2021

Opportunities across the yield curve

What’s the impact of new stimulus on the market and consumer?

Published April 21 2021
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Podcast Transcript
00:00
Steve Chiavarone: Hello, and welcome to the Hear and Now podcast and Federated Hermes. I'm Steve Chiavarone Portfolio Manager and Equity Strategist. And today I'm joined via video conference by Debbie Cunningham CIO for Global Liquidity Markets and Nick Tripodes Structured Products Portfolio Manager. Today, in our first installment of several episodes focused on liquidity, we'll discuss the recent stimulus and its impact on the consumer. Nick, if we may, let's start with you. In terms of the consumer, what's the impact that the new stimulus on the market and on different asset classes specifically?
00:35
Nick Tripodes: Thanks, Steve. I think the stimulus package is a very positive for fixed income asset classes, including structured products, which incorporates both mortgages and consumer related asset backed securities. If you look at some of the key benefits of the American rescue plan, for instance, there's a 300 dollar weekly unemployment benefit that's been initiated through the beginning of September. 1400 dollar stimulus checks on top of the 600 dollars that was enacted in December. Consumers will be getting 2,000 dollar checks and keep in mind, these are for consumers that make less than 150,000 dollars for married filers. There's also a 3,000 dollar tax credit, which could increase up to 3,600 dollars for children under age six. There's also 22 billion in rental assistance, 29 billion for the restaurant industry and also additional funding for the PPP program. This is really beneficial for mortgages. If you think about people paying their mortgages, especially lower-income people, this really provides additional funding to help pay their mortgage, keep on track there.
01:48
Nick: But then if you look at consumer ABS, for instance, credit card ABS, although prime borrowers have done very well during the pandemic because they've saved money on travel and leisure, and entertainment, and fuel, and things of that nature. For subprime borrowers who really have been infected by the pandemic, this will help them pay their credit card bills. This will help them pay auto loans, auto leases. If you look in the subprime areas, some borrowers have had to, in certain cases, 20% of borrowers had to get involved in forbearance programs. Now that this is really a way for them to get off forbearance programs and help them pay their loans and leases. It's also beneficial for student loans, personal loans. In addition, small companies that are able to get money through the payroll protection program will help them pay their payroll and meet their obligations as well. It's really a huge benefit for the entire consumer ABS area.
02:53
Steve: Yeah, Debbie, I want to get you in here, but we've noticed in some of our macro work, when you look at some of the financials for which provisioned against mountain of bad loans, they've really started to release some of those reserves as a sign that credit quality has actually remained remarkably resilient through this. From your purchase as CIO, what are your thoughts on the consumer and in particular, how they're responding to stimulants here?
03:19
Debbie Cunningham: Well, certainly to pick up from that, Steve, as well as what Nick was talking about. All types of consumer classes and receivables, whether they're in a traditional financial institution or a structured product, and for Liquidity portfolios that are within my domain asset back commercial paper is the largest one of those structured products. These are all huge validation. There's a lot of validation for these as our favorite prime asset class. They're very high quality traditionally, but with this extra stimulus that makes them even higher quality, they're quite diversified. And they're just extremely liquid from a collateral standpoint. All of that makes it again a very great asset class for performance reasons, both from a yield standpoint, because they are a little bit more complex on the structured side, but also from a safety standpoint.
04:21
Steve: Yeah. It really is. This has been a cycle essentially like no other. I mean, the rapid increase in unemployment that rapid decline in the unemployment rate that's occurred since. The relative strength of the consumer throughout in part because of the tremendous stimulus measures. Let's dig in on that and what makes this stimulus different? Especially from the last two, I'll just throw out a stat to start. I saw all of the 1.9 trillion that was passed. Currently 1.2 trillion has been to be dispersed this calendar year and upwards of 700 billion of that goes directly to the consumer. Let's talk about what makes this different and what some of the implications are there? Debbie, I'd like to start with you here as we address this issue.
05:07
Debbie: Sure. I'm just going to go through what I think are some of the more subtle differences. First of all, it's a year later, people are no longer panicking about what in fact they are allowed to do from a global lockdown standpoint and what they aren't allowed to do. One year later, people were comfortable going outside of their house for more than just watering their plants in the morning. There's a lot of pent up demand out there. And I think there's a bit more willingness to spend what has been provided to the consumer in the form of stimulus, not just saving it. Now, having said that what I've seen from a statistics standpoint so far for this third round of stimulus still has the largest portion of it, 40%, being put into savings with 35% of it being used to pay debt and 25% of it being used on a spend basis.
06:02
Debbie: That's up, it was 10% spending at the very beginning. We're moving in the right direction. I think, some of the things that will benefit from this are really the consumer discretionaries and travel and entertainment, travel and leisure things that we've all very much been missing over the course of the last year. Sports tickets, theater subscriptions, vacations. These are things that I think people are going to find as a top priority over the course of the rest of 2021. And you may see some inflation cropping up because of that, but those would be sort of what I call the subtle differences in what had been stimulus checks in rounds one and two. And now what we're experiencing so far, at least in round three.
06:52
Steve: Yeah, we'd agree. From a multi-asset perspective, we thought the first several bills were really more bridge financing, disaster relief type bills. Now we're firmly in that stimulus. You get out an economy that's back near full capacity, and now you're stimulating above. And as you know, we've been overweight exactly the parts of the market on the equity side, that you're talking about, those travel and entertainment, as we expect wallet share to move away from home improvement, away from staying at home plays and outdoors experiences and entertainment. Nick, I would love to get your thoughts on what you think some of the key differences here are between this package and maybe some of the stimulus packages that came up prior to?
07:33
Nick: Sure. In addition to what Debbie mentioned, if you look at just the details of the bills themselves, for instance, there's 1,400 dollars per person from this stimulus package where last December, I think it was 600 dollars per person. They've also increased the, or lowered the requirements. Now, adult dependents over the age of 17 are eligible. So college children and even students after college, there's still dependents are included. There's additional money flowing through households. Spouses of undocumented immigrants as well, where I think with the new administration being more friendly to undocumented immigrants, that's more money flowing into households. And also there's been an expanded eligibility to non-profit organizations under the payroll protection program. I think it's just a little more expansive program that's helping more people. And as we talked about the money flowing to the consumers. It is pretty substantial in this package.
08:39
Steve: We've also been focused on our side on the expanded child tax credit. And the fact that half of that expanded credit will start to potentially be paid in monthly installments in the back half of the year. And what that means in terms of smoothing out consumer spending, but also is it a trial balloon for something like a universal basic income? I know that's something that we're watching, that is a difference here as well. I want to switch gears a little bit and I'm going to lead off again with you here, Nick. We've talked about what's a little bit different, obviously we've talked about the consumer, we've touched a little bit on ABS, but let's talk about what sectors here in the market, in your area of the world that we think are most impacted by what's going on with the stimulus, with the general recovery as it progresses.
09:25
Nick: Sure. I mentioned before, if you look at the ABS market, so there's been very strong technicals in the ABS market. A lot of investors are interested in short-term paper. Not only do you have strong technicals, but now the fundamentals are getting better, especially on the subprime area from the stimulus package. So you have that convergence of strong technicals and improving fundamentals. The ABS market will continue to do well. Although we're not big investors in our space, in the municipal market, if you look at the state local governments, they're receiving 350 billion dollars in stimulus money. That's really a big boost for that municipal market. And we've seen that area improve as well. Small businesses continue to get a lot of money.
10:13
Nick: If you look at restaurants and childcare providers and then the public health workforce as well, a lot of money for COVID testing, tracing, vaccine distribution, et cetera. That's really improving the public health space. If you look at the least impacted bonds, I would probably say, corporate bonds, because with the exception of airlines, which are getting a lot of money. Performance in corporate bonds has actually done very well without all the additional stimulus money, returns have been pretty solid, and there's also a lot of money chasing short-term corporate bonds as well. Even though they haven't received as much money in the corporate space as the consumer has received, that market has done well.
10:58
Steve: Yeah, it's been interesting, following some of the corporate spreads and bankruptcies in particular. We've evaluated that corporate bankruptcy is once you get over those very small private businesses, that you get into the kind of more public sphere are all throughout the pandemic, I've run somewhere between a quarter and a third of what they did during the great financial crisis. The stimulus has really helped to shore up the corporates. Debbie, what would you like to add here in terms of areas or sectors of the market that you see some opportunity or some risks, and want to go forward basis?
11:32
Debbie: Well, because of some of the things that Nick was talking about in the context of who's receiving these funds, we think the construction industry will do quite well, some types of different consumer durables and in particular, we do see, we're pretty confirmed at this point that tax rates will be going up. We feel there will be financing that occurs in the municipal space, so increased supply and need there because of the stimulus to build better bridges, build bigger highways, improve various parts of our infrastructure. We think muni issuance will go up with taxes going up, we actually think this will have a huge demand on the liquidity space in the muni sector. It only makes sense when you kind of fill those gaps in with what the expectations are, even though we're not seeing those yet today.
12:27
Debbie: And then I think that the other thing I would note would be in some of the consumer side of the discretionary travel and leisure entertainment is just the concerns about inflation potential. And although we have been told by the Fed that is going to be something that's transitory and ignored by them for the most part in the context of it being something that's very short-lived, we do think it bears attention and we'll be following it as the second, third and fourth quarters of 2021 are undertaken.
13:04
Steve: Yeah. We started this podcast talking about how this is the first in a series of podcasts that we're going to do around this subject matter. And I think it's appropriate because it's not as though stimulus or government spending programs are done. What we have in place is not likely to be all that will come, there'll be more to come. There'll be more to digest, certainly on the infrastructure side, potentially on the social spending side, almost certainly on the tax side and that'll have implications for inflation or economic growth. And then obviously for not just the short end of the yield curve, but all the way out through the risk curve. Yeah, I think it's good that we'll be checking back in from time to time.
13:43
Steve: All right. So as we're looking to wrap up here, obviously Federated Hermes is known with a very strong reputation in money markets and liquidity space in general, but really there's a lot of expertise through the short end of the yield curve and beyond. And I want to explore that a little bit. As we think about clients who maybe don't have a liquidity needs in the short run and can go a little bit further out that curve, where do we see some opportunities? And I'd like to start with you, Debbie, and then we'll maybe go a little bit further out with you, Nick to follow.
14:20
Debbie: Sure. No problem. And you're absolutely right. We're at a rock bottom, low level for liquidity and money market yields at this point, but I'm going to start this answer or this discussion with what I would call an expectation that, that rock bottom rises even though the Fed is not necessarily in play in 2021. We do believe because of some of the inflationary potential in the economy that we could see the Fed starting to change their bond buying. We already had some discussions around that earlier this week. Later in 2021, which ultimately may mean from our standpoint that we see a Fed that's in place for actually moving interest rates in 2022, not 2023. And we've started to see that migration in the various dot plots as they've come out over the course of the last year.
15:18
Debbie: What I would say that we're focused on in 2021 is what is possible technical adjustments from the Fed, the potential expectation for the RRP rate, or reverse repo rate and IOER to be increased by five basis points is something that we think has a likelihood, and as such would add a few basis points to what you can get in or return from a money market yield standpoint. In addition, we've got supply that's coming into the marketplace from a financing standpoint for the stimulus checks. We talked about the stimulus and what needs to be financed in some way. And part of it can come from the Fed's balance sheet, but a large portion of it has to be financed through the treasury market. That additional supply will need to be purchased in the marketplace. And anytime you have a pickup and supply and not a commensurate pickup and demand, you usually have to have a few extra basis points of yield.
16:10
Debbie: I'll just start off with, even though the Fed is on hold, our expectation would be if you need the liquidity in a short period of time, money market funds are the best space you can have out there compared to other alternatives like bank CDs. And our expectation would be that those yields should be as we go forward in 2021 for those technical adjustments and that supply. Beyond that, obviously, as you mentioned, we've got the next sections of the yield curve that make a lot of sense. And with that alternative over to Nick to kind of carry it on from there.
16:49
Nick: Thanks, Debbie. As Debbie mentioned with the Fed on hold, at least for this year and possibly into 2022. There are opportunities to step out further in that yield curve and pick up additional yield and returns. If you look at the yield curve right now, we've seen a steepening of the yield curve, but most of that has taken place and the five-year treasuries and longer. It's been more anchored in that kind of zero to two year range. If you do step out on the yield curve and you move into some active cash investments that might have a duration of a half a year or even one year, you can pick up anywhere from 40 to maybe 60 to 70 basis points. You can also even step out a little bit longer into that low duration space and pick up some more additional yield and higher returns as well.
17:43
Nick: That's an opportunity we think, with the Fed being on hold for the time being, it kind of reduces some that interest rate risk. And if there is a movement on NAV on a find or on an investment, that yield advantage really allows you to compensate for that. And within a couple of months, you can recoup any possible fluctuations from that incremental yield advantage. I think now is an important time if you're an investor and you have an opportunity to move out from some of their cash for a longer term investments for money that you might not need for six months or a year, or a year and a half, there is a good opportunity to take that additional step out on the yield curve at this time.
18:29
Steve: Yeah. I just chime in with, as you think about a multi-asset portfolio, and as you're trying to put that together, it really does make sense to look at the entire range of solutions on the short end of the yield curve and use those. And there is some uncertainty, right? You have the Fed that's telling you that they don't want to move until 23, but we are having a kind of economic recovery that's quite robust and may put them in play earlier. Again, being able to utilize all those tools on the short end of the yield curve, I think behooves investors. With that, we're just at time. So Nick, Debbie, I'd love to thank you. And thank you to our listeners. We look forward to you joining us again on the Federated Hermes Hear and Now podcast. And if you enjoyed this podcast, we invite you to subscribe to the Federated Hermes channel to get every Hear and Now episode. Plus our other series, Amplified in Fundamentals for a global perspective on the issues, challenges and trends shaping the investment landscape. Thank you.
19:31
Disclosure: Views are as of 4/9/2021, 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. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. An investment in money market funds is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although some money market funds seek to preserve the value of your investment at 1.00 USD per share, it is possible to lose money by investing in these funds. Bank accounts and CDs, unlike mutual funds, are FDIC insured and offer stable principal. Longer term bonds and cash instruments offer higher return potential in exchange for greater risk and volatility. The value of some asset-backed and mortgage-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations. Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations. The yield curve is a 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. IOER is Interest on Excess Reserves. Federated Investment Management Company 21-30183 (4/21)
Tags Liquidity . Fixed Income . Fiscal Policy . Consumer Spending .
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.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

An investment in money market funds is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although some money market funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in these funds.

Bank accounts, unlike bonds, are FDIC insured and offer stable principal.

Longer term bonds and cash instruments offer higher return potential in exchange for greater risk and volatility.

The value of some asset-backed securities may be particularly sensitive to changes in prevailing interest rates, and although the securities are generally supported by some form of government or private guarantee and/or insurance, there is no assurance that private guarantors or insurers will meet their obligations.

Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

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.

IOER is Interest on Excess Reserves.

Federated Investment Management Company