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Update from the Re-Investment Desk - 2Q 2013

Highlights

  • Debate surrounding tapering of QE3 by the Fed continues, as the ECB and RBA cut interest rates
  • An overall seasonal reduction in T-bill inventory has driven levels down across product types
  • Issuers continue to adjust term unsecured issuance levels to incentivize longer dated funding

2Q Review

During the second quarter, the Federal Open Market Committee ("FOMC") and Bank of England left monetary policy unchanged, while the European Central Bank ("ECB") and Reserve Bank of Australia ("RBA") both delivered rate cuts in May. At the June FOMC meeting, the Fed sounded more confident in the outlook and in the economy's ability to grow without the need of ongoing extraordinary support, and introduced the possibility of moderating the monthly pace of purchases later in the year. The ECB delivered on a cut to the main rate, and deliberated over further cuts, including a potentially negative deposit rate. In Australia, the RBA surprised most with a rate cut in May, maintaining an easing bias, while June minutes showed there is no urgency for lower rates in the near term. The June FOMC meeting and potential tapering of the current Quantitative Easing ("QE3") program led to an increase in financial market volatility. However, given the high levels of excess central bank reserves globally, short duration markets remained calm, and rates continued to be driven by issuer supply and demand conditions.

Outlook

In the U.S., we expect Treasury Bill supply to remain negative into July, continuing to provide improved spreads between term unsecured investments and lending fixed income collateral, while also putting downward pressure on U.S. term rates, as investors continue to search across short dated product types for higher yields. In Europe, speculation over further central bank action, and ongoing passive tightening from Long-Term Refinancing Operation repayments to the ECB, will continue to provide uncertainty on short-term rates and provide yield curve opportunities in longer tenors. With overnight investments remaining at consistently low levels, issuers are likely to take advantage of market demand in order to lengthen their maturity profiles, and may continue to restrict or eliminate shorter dated offerings. We expect speculation to continue around when the Fed will begin to taper its monthly asset purchases, although the Fed has stressed this remains extremely data dependent. In Australia, despite the recent weakening of the AUD and the upcoming elections, we anticipate the RBA to cut rates again in 2013, which will most likely occur in the fourth quarter rather than the third, the book will be positioned accordingly. Issuance is likely to remain limited in the AUD commercial paper market, with further redemptions in programs reducing the already minimal supply. Therefore, where the yield opportunity allows, diversification will be sought through increased investment in offshore issuers.

Our strategy will remain focused on maintaining liquidity overnight and through our maturity structure by layering bank and corporate investments in the 1- to 3-month maturity ranges, although we anticipate levels and available supply in these tenors to continue to decrease. We will selectively target investments in the 4- to 6-month tenors where we expect to receive a premium over available 3-month yields of up to 10 basis points, as levels in the longer dates will continue to vary on an issuerby- issuer basis. We will continue seeking attractive opportunities for core holdings in longer dated, high-quality investments for eligible accounts, generally out to one year. These trades offer incremental yield and further diversification by providing access to some of the higher quality names that are no longer actively issuing in the shorter dates due to the excess liquidity that remains in that end of the market.

 
 

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