Looking on the bright side

Football season is upon us, but the biggest end-around is not on the field but in Washington as President Trump is trying another way to influence the Federal Reserve. But before I address his attempt to remove Fed Governor Lisa Cook, I’d like to discuss some positives in the money markets.

• Plumbing is in great shape It’s no wonder that the financial media, advisors, investors and, of course, firms within the industry have focused on the attractive yields of stable value investments over the last three years. It’s been an extraordinary run, which we think could continue even after the Fed eases rates further. But less noticed is the excellent state of the fundamentals. I’d argue that overnight trading is the healthiest since 2008, judging by the robust supply brought or sponsored by traditional counterparties that has greatly reduced the use of the Fed’s Reverse Repo and the Standing Repo facilities. Banks are the major players, and their credit continues to be high, with low nonperforming assets, fewer charge-offs and elevated liquidity. The whole system works best in conditions like this and should inspire continued confidence for cash managers.
• New Kids on the Blockchain As I often say, money market managers are wise to be conservative. With goals of liquidity, stability and preservation of principal, we must tread carefully when approaching new technology. Blockchain structure has been around for decades, of course, but the cash management industry has only recently developed products that use it. With that cautious approach and extensive evaluation, we are proud to participate with BNY and Goldman Sachs in their initiative to offer tokens that represent the value of the shares, with BNY using blockchain to maintain a mirror record of share ownership. It was innovation that created the first money market funds, and digitalization has the potential to enhance the growth prospects of the liquidity industry.
• Genius? It is rarely a good idea to call yourself a genius. Just ask Wile E. Coyote. But we think the Guiding and Establishing National Innovation for US Stablecoins Act, or GENIUS Act, provides necessary regulation of the stablecoin market. Again, with appropriate caution, it should lead to more opportunities for liquidity products, particularly government money market funds, given the new requirements for permitted stablecoins in the US to be backed one-to-one by certain high-quality liquid assets.
• Munis moving on up In the tax-free money fund space, the already steep municipal yield curve could get steeper if/when the Fed resumes cutting rates. This should mean increased supply, with 1-year notes already trending toward the third straight year of growth exceeding 10%. With the uncertainty of the Trump administration’s tax and spending bill behind us, we think demand from technical factors, such as the reinvestment of matured securities and coupon payments, will weaken, which historically produces stronger taxable equivalent performance for SIFMA.

Back to the Fed. I read Chair Jerome Powell’s keynote address at the Jackson Hole, Wyo., central bank symposium as being more hawkish than many commentators did. He said, “the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance,” which later in the speech he called “modestly” restrictive. To my mind, this does not justify the market confidence of a quarter-point cut at the coming FOMC meeting. However, we think the Fed will move. With the economy slowing and, unfortunately, Trump’s continued pressure, the path of least resistance will likely prevail. July’s PCE growth showed a slight, but not concerning, increase from June. Fed officials will have an additional CPI and labor report to digest before making their decision; but barring a surprise, they will probably not prevent the cut.

That Trump’s attempt to fire Cook for alleged mortgage fraud has not provoked another bond market beatdown is partially due to relative indifference and partially that her wrongful termination suit will play out in the courts for some time. The Fed needs to push back for many reasons, but one is that it should be the body that investigates this. If it is true, Powell will have to consider pushing her out as he likely did when Fed Vice Chair Richard Clarida resigned in the wake of scrutiny about trades he executed in the days before the emergency rate cuts in February 2020. But bond vigilantes need to be, well, vigilant, ready to do their own pushback soon lest the critical independence of our central bank fade.