Sky high Sky high http://www.georgiaprime.com/ga/static/images/ga/ga-logo-amp.png http://www.georgiaprime.com/ga/daf\images\insights\article\sky-clouds-small.jpg September 30 2024 September 30 2024

Sky high

Interest rates have fallen, but in the liquidity space, the sky has not.

Published September 30 2024

The Chicken Little predictions that the Federal Reserve easing cycle would lead to an exodus of assets from liquidity products have been proven wrong. Money market funds across the industry alone have experienced inflows of around $150 billion since the Fed cut rates by 50 basis points in mid-September to a range of 4.75-5%.

It’s another case of the disconnect between some media pundits and investors. The former want their opinions heard, and bad news gets more attention. The latter simply want the highest possible return across their portfolio, whether they invest in liquidity products to offset riskier holdings or for future deployment to other investment opportunities.

Historically, in a falling-rate environment, yields of cash management products lag the direct security market. Why? Because some of their holdings have locked in higher rates, and most of those won’t mature until later, at some point in the next 12 months—referred to as a laddered strategy. In contrast, some securities in the direct market—especially overnight securities and those with floating rates—trace Fed moves immediately, as does the Reverse Repurchase Facility, which now sits at 4.80%. History is only a guide, of course, but we think this will be the case as the easing continues. 

Some cynics channeling Henny Penny—the original name of that apocalyptic-minded chicken in the European folk tale—characterize the magnitude of the half-point reduction as a mortal blow. We think that actually helps cash-like vehicles because the decline in their yields traditionally has been proportional to the cut. Had the Fed trimmed the target range by a quarter-point, liquidity yields likely would have a spread of around 12 basis points initially. As it stands, that difference is closer to 25 basis points due to the oversized cut, and gets more attractive out the inverted yield curve. No wonder the inflows.

Strike that?

The Fed has tacitly declared victory over inflation, and the August PCE report supports that. Core PCE, which strips out volatile elements such as energy and food prices, rose only 0.1% from July against expectations for a 0.2% gain. But inflation might reverse course if the port workers across the Eastern seaboard go on strike. The Fed typically ignores exogenous events as being too temporary to warrant a monetary policy response. But the disruption to supply chains is not easily predictable. While it likely won’t be as disruptive as the pandemic, it probably would be worse than the interference caused by the cargo ship stuck in the Suez Canal, terrorist attacks in the Red Sea and the tragedy in Baltimore combined. If a strike by longshoremen is prolonged, inflation could rise to the point that the Fed could hold rates at one of the year’s last meetings.

Doing just fine, thank you

The implementation of the SEC’s money fund rules is finally upon us. On Oct. 2, we get the last phase, which imposes mandatory liquidity fees on institutional prime and institutional municipal money market funds. A fee would only be charged only if net redemptions exceed 5% of a fund’s net assets and the cost of liquidity (including, transaction costs and market impact costs) exceeds 0.01% of the value of the total shares redeemed on that day. Despite our lasting opinion that the “reforms” were not necessary, it is good to finally close the chapter. The liquidity industry has risen to the occasion despite the operational challenges, and we believe the inflows this year show that the efficacy of these products remains intact.

Central bank news

Policymakers of three other major central banks met in September. Sluggish growth across the eurozone and cooling inflation, which fell to an annualized 2.2% in August, may have encouraged the European Central Bank to cut its deposit rate by 25 basis points to 3.5% last month. It was its second reduction this year, following its landmark cut in June. The Bank of England’s Monetary Policy Committee voted to leave rates unchanged at 5%, after reducing rates by 25 basis points at its meeting in August. Lastly, the Bank of Japan did not raise rates last month, saying it wanted to take its time and monitor other countries. Although Governor Kazuo Ueda said Japan’s economy is progressing well, he is concerned about the global picture: "The outlook for overseas economic development is highly uncertain. We need to scrutinize such developments carefully for the time being."

Tags Liquidity . Monetary Policy . Markets/Economy .
DISCLOSURES

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.

Yield Curve: 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.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

An investment in money market funds is not a bank account and is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although some 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.

The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results. 

This is a marketing communication. The views and opinions contained herein are as of the date indicated above, are those of author(s) noted above, and may not necessarily represent views expressed or reflected in other communications, strategies or products. These views are as of the date indicated above and are subject to change based on market conditions and other factors. The information herein is believed to be reliable, but Federated Hermes and its subsidiaries do not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. 

This document is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities, related financial instruments or advisory services. Figures, unless otherwise indicated, are sourced from Federated Hermes. Federated Hermes has attempted to ensure the accuracy of the data it is reporting, however, it makes no representations or warranties, expressed or implied, as to the accuracy or completeness of the information reported. The data contained in this document is for informational purposes only, and should not be relied upon to make investment decisions. 

Federated Hermes shall not be liable for any loss or damage resulting from the use of any information contained on this document. This document is not investment research and is available to any investment firm wishing to receive it. The distribution of the information contained in this document in certain jurisdictions may be restricted and, accordingly, persons into whose possession this document comes are required to make themselves aware of and to observe such restrictions. 

United Kingdom: For Professional investors only. Distributed in the UK by Hermes Investment Management Limited (“HIML”) which is authorised and regulated by the Financial Conduct Authority. Registered address: Sixth Floor, 150 Cheapside, London EC2V 6ET. HIML is also a registered investment adviser with the United States Securities and Exchange Commission (“SEC”).

European Union: For Professional investors only. Distributed in the EU by Hermes Fund Managers Ireland Limited which is authorised and regulated by the Central Bank of Ireland. Registered address: 7/8 Upper Mount Street, Dublin 2, Ireland, DO2 FT59. 

Australia: This document is for Wholesale Investors only. Distributed by Federated Investors Australia Services Ltd. ACN 161 230 637 (FIAS). HIML does not hold an Australian financial services licence (AFS licence) under the Corporations Act 2001 (Cth) ("Corporations Act"). HIML operates under the relevant class order relief from the Australian Securities and Investments Commission (ASIC) while FIAS holds an AFS licence (Licence Number - 433831).

Japan: This document is for Professional Investors only. Distributed in Japan by Federated Hermes Japan Ltd which is registered as a Financial Instruments Business Operator in Japan (Registration Number: Director General of the Kanto Local Finance Bureau (Kinsho) No. 3327), and conducting the Investment Advisory and Agency Business as defined in Article 28 (3) of the Financial Instruments and Exchange Act (“FIEA”). 

Singapore: This document is for Accredited and Institutional Investors only. Distributed in Singapore by Hermes GPE (Singapore) Pte. Ltd (“HGPE Singapore”). HGPE Singapore is regulated by the Monetary Authority of Singapore. 

United States: This information is being provided by Federated Hermes, Inc., Federated Advisory Services Company, Federated Equity Management Company of Pennsylvania, and Federated Investment Management Company, at address 1001 Liberty Avenue, Pittsburgh, PA 15222-3779, Federated Global Investment Management Corp. at address 101 Park Avenue, Suite 4100, New York, New York 10178-0002, and MDT Advisers at address 125 High Street Oliver Street Tower, 21st Floor Boston, Massachusetts 02110.

Issued and approved by Federated Investment Management Company

23205604