Insights from Our Re-Investment Desk - Issue 1, 2014
- At the December meeting, the Fed tapered the monthly pace of their asset purchases by $10 billion
- Issuers are likely to continue to favor floating rate products or alternative structures which provide them with the longer dated funding that will fulfill regulatory requirements
- Investments will remain focused within the three month tenor, selectively targeting opportunities in the longer dates
Fourth Quarter Review
At their December meeting, the FOMC tapered the monthly pace of their asset purchases by $10 billion, split evenly between Treasuries and agency mortgages. The key message regarding tapering is that the decision to taper is data dependent and not predetermined. The Fed also strengthened its forward rate guidance, saying it will be on hold “well past” a decline in the unemployment rate below 6.5%. In USD, repo supply remained scarce in the shorter dates. However, the Fed’s overnight fixed rate reverse repo facility assisted in providing a soft floor for short rates, as well as some needed supply and an additional outlet for liquidity. In Europe, at their November meeting, the ECB cut the base rate to 0.25%, while leaving the deposit rate unchanged at zero, following a marked decline in Euro zone CPI inflation. However, impact on market rates was limited given that the base rate and currently declining levels of excess liquidity continue to be more important in shaping money market rate expectations. The RBA kept the cash rate steady at 2.50% throughout the final quarter of 2013. The market reacted with a flattening of the yield curve and accordingly, one through six month tenors traded in a very tight range. Globally, term activity declined approaching year end as issuers met their funding requirements and investors completed their positioning for year end. European counterparties were additionally affected by preparation for the ECB Asset Quality Review snapshot.
Heading into 2014, we anticipate issuer levels will remain range-bound with a downward bias in the U.S. It is likely that issuers will continue to favor printing floating rate products or other alternative fixed structures which will provide them with the longer dated funding that fulfills various regulatory requirements. This should continue to impact the universe of active names in the shorter tenors, likely providing downward pressure on offered levels. We expect that the Fed will either extend the test phase of their overnight repo facility, or decide to make it permanent at their January meeting. The ECB is expected to hold rates low for a prolonged period of time, but we do not expect any policy rate changes in the near term, absent a downside surprise to inflation or growth. EUR rates will also continue to be driven by the ongoing decline in levels of excess liquidity, and we anticipate some increased short dated rate volatility, and maintain a preference for floating rate products where available. The RBA is expected to keep rates on hold into the near future, however should the economy show signs of weakness and the Australian Dollar remains resilient, this would leave the door wide open to another 25bp rate cut in 1H 2014.
Overall, our global strategy continues to focus on maintaining liquidity overnight and through our maturity structure, by layering bank and corporate investments in the one to three month maturity range. We will continue to optimize account liquidity structures by utilizing term repo along with other alternative investments where eligible, to reduce reliance upon overnight repo, where supply is increasingly limited. We will selectively target negotiable investments in the four to six month tenors where we expect to receive a premium over available three month yields of up to 10 basis points. We will continue to seek attractive opportunities to diversify and add incremental yield in core, longer dated, high quality investments for eligible accounts, out to one year, and will include issuers that are no longer active in the shorter dates due to funding requirements.