Insights from Our Re-Investment Desk - 3Q 2013
- The September Federal Open Market Committee (“FOMC”)meeting held a surprise as the Federal Reserve refrained from a widely expected taper
- Issuers in expanded regions experienced increased demand as supply from many issuers remained limited
During the third quarter, expectations were for the FOMC to begin tapering at the September meeting. However, the Federal Reserve decided to postpone, citing fiscal policy as well as the potential impact a government shut down or a failure to raise the debt limit would have on growth. In Europe, the European Central Bank ("ECB") and the Bank of England also left policy unchanged, with the ECB making continued efforts to guide market expectations with comments that they remain attentive to liquidity conditions and market rates. The Reserve Bank of Australia ("RBA") cut to 2.50% in August, also as expected. The minutes of the board meeting noted that they "should neither close off the possibility of reducing rates, nor signal an imminent intention to reduce rates further." The markets took this as a signal that the RBA could have reached the end of the rate cut cycle. USD and EUR repo remained at depressed levels, maintaining a consistent positive spread between term unsecured investment yields and lending fixed income general collateral in an environment which has remained challenging for this asset class. In USD, demand for alternative products remained robust as investors continued to seek higher yields for their cash away from the repo market. Strong demand has remained for floating rate products, with maturities of one-year and longer.
In the U.S., heading into the final quarter, we anticipate downward pressure to remain on most repo, bank and corporate products. However, while uncertainty remains surrounding the debt ceiling, we expect heightened volatility in levels, particularly for repo, to continue. This will compress the spread between investment yields and the lending of fixed income general collateral. In Europe, while the ECB remains on hold, with declining excess liquidity levels and an increasing focus on the expiring Long-Term Refinancing Operation ("LTRO") programs in 2015, a new LTRO operation remains a possibility. In the meantime, current liquidity levels and the declining EUR/ USD FX basis has put upward pressure on the yield curve, including at the front end, assisting investment yields. In AUD, given the desk view that the market may be under-pricing the probability of a rate cut in the near term, we continue to buy duration by adding high credit quality exposures in the three- and six- month part of the curve. 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 anticipate the availability of repo collateral supply for overnight investments to remain limited, driven by counterparty requirements, to efficiently manage liquidity and balance sheet usage. We will continue to optimize account liquidity structures by utilizing term repo along with other alternative investments, where eligible. 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 seeking attractive opportunities to diversify and add incremental yield in core longer-dated, high quality investments for eligible accounts, with a majority of our interest out to one year. This often includes issuers that are no longer active in the shorter dates due to their funding profile requirements.