Extra innings

The Federal Reserve has had the markets running on a treadmill for several months. The despairing tone of the statement from yesterday’s FOMC meeting indicates we won’t step off anytime soon: “In recent months, there has been a lack of further progress toward the Committee's 2% inflation objective.” Ouch. Goes almost without saying that the target fed funds range remained at 5.25-5.5%.

But a better analogy is that we have entered extra innings in the game against inflation. It just won’t give up. But despite the recent disappointing CPI and PCE readings, Chair Jerome Powell said yesterday he still expects price pressures to decline this year and that the Fed will cut rates eventually. (He seems plenty confident in that despite constantly saying he lacks confidence). In our view, the U.S. economy isn’t moving backward or running in place, but simply in overtime in a game in which cash remains king. Two cuts are likely the most we will get this year.

This makes investing tricky. Moving out of liquidity vehicles too soon might mean losing out on yield if the contest stretches on; but waiting to extend the duration of a portfolio until the first cut can lead to the same. We are sticking to our game plan of keeping our weighted average maturities long as we seek higher-yielding securities and paper further out the yield curve. This is no time to let up.

Tapering plans revealed

A game within the policy game has been the Fed ’s steady reduction of its balance sheet, which grew from huge to colossal during the pandemic. Since June of 2022, it has allowed $60 billion of Treasuries and $35 billion of mortgage-backed securities (MBS) to mature without replacing them. Yesterday, the FOMC announced it would taper this amount starting in June by lowering the monthly cap on Treasuries from $60 billion to $25 billion, while keeping the MBS cap at $35 billion. The Fed is keen to get out of the mortgage sector, so the status quo there was expected. It was good to hear Powell actually say the Fed is tapering gradually to minimize the chance the money markets experience stress. We are all for that.

Phase three on deck

The second of four phases of the new SEC money market rules went into effect last month with no notable bumps across the industry. Money market funds now must maintain at least 25% in daily liquid assets (previously 10%) and at least 50% in weekly liquid assets (previously 30%). Tax-exempt money funds are not subject to the daily requirement. The third phase, which arrives next month, is entirely administrative. Its changes primarily concern mandatory reporting, such as if a money fund invested less than 25% of its total assets in weekly liquid assets or less than 12.5% of its total assets in daily liquid assets. Phase four, which imposes mandatory fees on institutional prime and institutional municipal funds if net redemptions exceed 5% of fund’s net assets, comes in October. None of the so-called reforms change our conviction that liquidity vehicles are an important and viable option for investors.

Liquidity at large

In contrast to the fireworks the Bank of Japan (BoJ) launched in March by hiking rates for the first time in 17 years, the world’s major global banks refrained from rate action in April. Actually, the BoJ produced the most notable news again when its decision to keep rates in its new range of 0-0.1% seemed to shake confidence in the yen, which weakened. The rest held no meetings or were noncommittal through speeches. Some seem inclined to see inflation fall further before cutting (the Bank of England, Bank of Canada), some have hinted a cut might come this summer (the European Central Bank’s first of this cycle and the Swiss National Bank’s second), and one, the Reserve Bank of Australia, has faced calls to raise rates as inflation there remains high.