Encouraging elements of new Fed framework
If the Fed's strategy to spur inflation works better than expected, hikes might come sooner.
Like so many derailed plans in 2020, the Federal Reserve intended its major revision of its “Statement on Longer-Run Goals and Monetary Policy Strategy” to be its momentous policy announcement of the year. Unlike the calibrations that happen in Federal Open Market Committee (FOMC) meetings, this document frames everything U.S. policymakers do. The only thing more fundamental is the Federal Reserve Act that established the central bank in 1913. And it isn’t updated often—the last overhaul happened in 2012.
Of course, Covid-19 happened and the Fed had much more urgent issues. But apparently it still wanted a big stage for the announcement and the annual Jackson Hole, Wyo., symposium of world central bankers fit the bill. And even though it was virtual this year, Chair Jerome Powell unveiled it last week to open the conference.
So, what in the document pertains to cash management? On the surface it seems dire, but it really isn’t. The unfortunate news is the Fed essentially adopted a lower-for-longer stance. It won't raise rates when the economy is getting better—like it did under Janet Yellen (and Powell)—only when conditions are robust.
But this approach simultaneously is the good side of the new framework for the liquidity space. Previously the goal was to hit an inflation rate (measured by PCE) of 2%. Now the Fed is OK with a temporary rise above that level, primarily by doing what it can to raise employment. The key phrase here that “policy decisions must be informed by assessments of shortfalls of employment from its maximum level.” Officials have long thought that full employment drives inflation higher, but that hasn't been the case recently. So it will let the labor market run as hot as needed to get to 2%, even if it overshoots that target for "some time." My position is this, combined with the other Fed moves this year, might spur inflation sooner than many think after the pandemic ends, meaning the FOMC could raise rates sooner and yields in the liquidity space should rise. If more people are employed and spend that income, we will get an uptick in demand amid a scarcity of supply. The Fed might not believe in the Phillips Curve anymore, but it can’t change that economic law.
On the fiscal side, it was disappointing Congress couldn’t reach a deal on a new stimulus package in August. In addition to hurting those laid off or furloughed, the delay has negatively affected retail sales and short-term Treasury and financial paper rates. We hope that a bill will be passed in September, but it is an election year, so who knows.
The race to replace the London interbank offered rate (Libor) heated up in August. Lately, the Fed’s Secured Overnight Financing Rate (SOFR) isn’t looking like a perfect replacement. SOFR certainly will be the new benchmark, but it has yet to establish a term yield curve and doesn’t have a credit component. Other indexes are being considered as viable alternatives to some lending transactions. The other issue is that Libor is a benchmark across different currencies, while SOFR is based only on U.S. securities. This is all a little troubling with only a year and a half to go. We continue to provide feedback to the Fed’s Alternative Reference Rates Committee and various street firms to address these concerns.
Industry flows in the cash space were sideways in August, ending the month not much different than from where they started. We kept the weighted average maturities of our funds in target ranges of 35-45 days for government and 40-50 days for prime and municipals.