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Month in Cash: The Fed shows its hand (and it's not as dovish as the headlines suggest)
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As of 02-02-2012
The cash curve flattened in January as longer-dated securities fell slightly while yields on overnight paper rose, with the bulk of the move occurring the last half of the month, when a jump in Treasury supply hit the cash market. Market participants, however, were mostly focused on the Federal Reserve’s regularly scheduled policy meeting in late January, after which the central bank revealed for the first time specific forecasts for benchmark interest rates from each (unnamed) participant.
Besides enhanced transparency—an oft-stated goal of Chairman Ben Bernanke—the Fed’s new policy of openness revealed a stunning change of plans, potentially extending the era of virtually free money for another 18 months, to at least late 2014. With the date of the first rate hike pushed much farther into the future, investors felt emboldened to venture farther out the yield curve, pushing longer-dated yields lower even as overnight repo rates reached 20 basis points. Overall, the one-month London interbank offered rate (Libor) fell 3 basis points to 0.26%, three-month Libor declined 4 basis points to 0.54%, six-month Libor shed 3 basis points to 0.78%, and one-year Libor dipped 3 basis points to 1.1%. Meanwhile, the yield on the U.S. Treasury’s two-year note, often viewed as a leading indicator of benchmark interest rates, closed the month down another three basis points to 0.22%.
'Exceptionally low' doesn't necessarily
mean no rate hikes
News from the domestic economic front was mostly positive in December. Retailers generally reported solid holiday sales, initial unemployment claims continued their gradual decline, some housing metrics showed clear improvement and consumer confidence unexpectedly rose, probably in response to the promising jobs data. Indications that the U.S. economy was pulling out of its summer soft patch further reduced the probability of the Fed initiating a third round of quantitative easing, or the purchasing of Treasury debt with newly printed money. For savers, the absence of a QE3 is positive, since heavy Fed bond buying would exert more downward pressure — albeit indirectly — on short rates and imply that policymakers were moving farther away from the first rate hike.
As the New Year unfolds, investors will be casting a watchful eye on Europe. During the first few months of 2012, Italy will need to rollover massive amounts of government debt, and while recent action by the European Central Bank to extend longer-term loans to the region's struggling banks will significantly reduce the possibility of a liquidity crisis, major sovereign solvency issues remain unresolved. We are carefully monitoring financial conditions in the euro zone and are maintaining sufficient cash to invest if the yield curve continues to steepen in coming months. |
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Light at end of low-rate tunnel?
Some money fund investors understandably let out a collective gasp at the surprising FOMC decision to potentially retain its "exceptionally low'' benchmark rate another 18 months. Since the announcement, the late 2014 target date for possible initial tightening seems to be the main takeaway. But accompanying data aimed at offering insight into committee thinking indicates that, like so many newspaper stories, the headlines may be more sensational than the substance.
Of the 17 FOMC participants, three foresee the first rate increases occuring this year, another three see tightening starting in 2013 and five see it coming in 2014. In addition, once tightening begins, several members think it could happen at a faster pace than expected. For example, two of the three who see tightening starting this year put the rate at 1% by year's end. One put the rate as high as 2% next year, and one put the rate as high as 2.75% in 2014. Moreover, the members' longer-run benchmark rate ranged from 3.75% to 4.50%.
Of course, only 10 FOMC members currently vote, led by Chairman Bernanke, whose influence is substantial and whose bias when it comes to tightening appears to be one of delay. But for money fund investors hoping for a little something more sooner than headlines suggest, it's worth noting that a fair number of Fed officials are more hawkish than their boss and that “exceptionally low'' doesn’t necessarily mean zero to 0.25%.
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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.
An investment in money market funds is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although 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.
Investors should carefully consider the fund's investment objectives, risks, charges and expenses before investing. To obtain a summary prospectus or prospectus containing this and other information, contact us or view the prospectus provided on this website. Please carefully read the summary prospectus or prospectus before investing.
Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.
London interbank offered rate (Libor): The rate at which banks can borrow funds from other banks in the London interbank market. The Libor is fixed on a daily basis by the British Bankers' Association and acts as a benchmark for other short-term interest rates.
The cash-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.
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Federated Securities Corp., Distributor
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