Less of zero
Investors have been given plenty of alphabet soup since the onset of the coronavirus. Among the first servings were special purpose vehicles such as the Money Market Mutual Fund Liquidity Facility (MMLF), Commercial Paper Funding Facility (CPFF) and Primary Dealer Credit Facility (PDCF). Then came Congress’ CARES Act and a slew of others.
More recently, new letters have turned up to forecast the shape of the GDP curve as the U.S. economy recovers from recession. They range from an optimistic prediction of a V-shaped curve to the pessimistic L-shaped one. Our base case is for a U. As communities continue to lower restrictions, we think the economy can recover sooner than many expect. If there are too many hiccups or false starts—or if we see a resurgence of Covid-19 infections—the bottom of the U will be longer. But what we have seen in the last month as the U.S. and other countries begin to open up is encouraging.
No matter the shape of the curve, we aren’t expecting a return to the extended zero-rate time frame of 2008 to 2016, but one best measured in quarters, adding up to a couple of years at most. The minutes of the April Federal Open Market Committee revealed this was the Fed’s consensus. If anything, the Fed seems to be quietly formulating a withdrawal strategy. Policymakers have reduced daily and weekly purchases of Treasuries and are considering raising the floor on overnight reverse repo rates to five basis points. And, they know that some of the new facilities, especially the CPFF, are not getting much usage, as bid/ask spreads have normalized.
The Fed has been anything but quiet in its pushback on negative rates. In May, policymakers repeated many times they are satisfied that their present tools, such as forward guidance, quantitative easing and lending programs, are effective and that pushing rates below zero is not on the table. Unlike the novel nature of many of its new facilities, there is plenty of evidence of the ineffectiveness of negative rates from the European Central Bank and the Bank of Japan. Fed officials know the score. But many in the marketplace simply aren’t listening (don’t fight the Fed!) as seen in the recent trading of the fed funds futures contracts in negative territory for early 2021. If you know anything about cash managers, you know we are a conservative bunch, so it should come as no surprise the money fund industry has been exploring what operational changes would be needed if rates did slip below zero.
In May, inflows to the liquidity space were more diversified. The concentration in government funds is still high (although they saw outflows last week), but the prime and municipal sectors have been receiving assets. The bill curve has improved, with yields in double-digit basis points. Spreads between prime and government securities tightened in May as London interbank offered rates (Libor) continued to fall. The Sifma Index also fell, due in large part to dealers returning inventory to the marketplace in the midst of an uptick in demand. The weighted average maturities of our funds lay in the middle of our target ranges of 35-45 days for government and 40-50 days for prime and municipals.