Even though we had an FOMC meeting last week we are being inundated with Fed speak again with almost every FOMC member opining on the economy and US policy this week. The headliner, however, was Chair Powell paired with Treasury Secretary Mnuchin testifying before the House Financial Services Panel yesterday. They will repeat the performance tomorrow before the Senate Banking Committee. The testimony was devoid of anything earthshattering, and while Powell and Mnuchin got high marks for their stewardship through the pandemic, Powell was forceful in saying monetary policy alone can’t finish the job and that more fiscal help is necessary. While much of the CARES Act programs have expired or are expiring, Congress has dallied over a new bill and now with a Supreme Court seat to fill they may be hard pressed to even pass a continuing resolution that will keep the government open after September 30 much less a Stimulus 2.0 bill. So while Powell and Mnuchin said they will do everything they can to assist the economy, Powell’s plea for additional fiscal help may not be heeded, at least not in the immediate future.
While the Fed outlook from last week’s FOMC meeting was more upbeat than the June forecast, it still projects rates unchanged through 2023 as shown in the Dot Plot below. Powell has been adamant that returning the economy to health first involves getting the virus under control. And seeing the experience in Europe right now where cases are spiking after having flattened the curve in the spring and summer offers some sobering news. Especially in light of US case numbers starting to rise just as the fall season has arrived and never having flattened the curve anywhere close to the European experience. Thus, Powell and the Fed’s hesitance to foresee a V-shaped recovery, rather something more like a W-shaped one, is likely a result of the expected resurgence of the virus this fall and into winter 2021.
And while some point to a vaccine as market positive, that is more than likely a 2021 event and getting it distributed across the country pushes the date of a return to anything like pre-pandemic normal deeper into the year. That’s another reason for the Fed’s tentative outlook for rates which is lower for longer and that longer may well stretch farther than anyone would have thought back in March.
New Portfolio Investment Focused on Short-End
Following up last week’s article in the S&P Global Market Intelligence was one yesterday that looked at the changes in bond portfolios during the second quarter. The article noted an increase in portfolio size given the slowdown in lending and the increased liquidity sitting in most banks. They also noted most of the increase went into short duration assets as the bar chart shows with bonds under three years to maturity increasing more than a 1% in the second quarter while a drop in bonds maturing in 15 years or longer was also noted.
It’s a typical knee-jerk response given the uncertainty of the duration of the liquidity currently sloshing around in banks but its not the strategy that we have been advocating here nor following in our own portfolio.
As mentioned in the previous section we think the road to a full recovery will be a long one filled with lots or retracement along the way. And we have noted too in recent articles, and certainly after last week’s FOMC meeting, that the Fed will be leaning on getting the economy back to full employment and thus using its monetary policy tools (i.e., zero lower bound Fed Funds, QE, and special purpose programs) to keep rates from moving too far away from current levels in order to support that recovery. Thus, we have been advocating to take on longer duration bonds, especially as most bank balance sheets are asset-sensitive. It’s not that we find great yields further out the duration curve, but they are certainly greater than what’s closer in on the curve near the zero lower bound. Remember, it’s a spread business and if you can get 50-100bps over funding costs that may at least slow the narrowing in net interest margins.
Agency Indications — FNMA / FHLMC Callable Rates
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