Positioning Your Portfolio as the Fed Tightens Monetary Policy

Transcription

1 Positioning Your Portfolio as the Fed Tightens Monetary Policy Scott Wood Portfolio Strategist January 30, 2018 Securities offered through ProEquities, Inc., a registered Broker-Dealer and Member of FINRA and SIPC. Protective Securities is a division of ProEquities, Inc. Securities and insurance products offered are not financial institution deposits, have no financial institution guarantee, not FDIC/NCUA insured, and may involve loss of principal 1

2 Agenda Economy and the Fed Look back and a look ahead Markets Rate Projections Still many unknowns Investment Strategies for Credit Unions Shorten duration Federal Reserve 2

3 Changes at the Fed Jerome Powell becomes new Fed Chair in February, once Yellen retires Currently a Fed Governor, confirmed as Fed Chair by Senate on January 23rd Vice Chair Fischer resigned, no replacement yet San Francisco Fed President John Williams recently mentioned as a candidate Fed Governors Quarles recently confirmed, Goodfriend nominated Lael Brainard remains, Tarullo resigned in 2017 Trump stills needs to appoint Vice Chair and two more Governors New York Fed President Dudley retiring mid 2018 Permanent voting member New voters this year Mester (Cleveland), Williams (San Fran), Bostic (Atlanta), Barkin (Richmond) Expected to continue with current rate policy but enforcement likely to change The Fed Tightens FOMC increased overnight rates by 25bps three times in 2017 Raised rates at meetings with a scheduled press conference (skipped September) Fed says to expect three 25bp increases in 2018 First increase likely on March 21 st Press conference meetings March 21, June 13, September 26, December 19 About providing ammunition for a future downturn, inflation hasn't been a problem Will continue reduction of balance sheet Will gradually increase the pace but will fully prepare markets for any changes Fed will continue to search for inflation in 2018 Will we see wage inflation with corporate tax cuts? 3

4 Historical Fed Funds Rate Fed Funds Effective How much more will Overnight Rates Increase? 8.00 Fed Funds Effective

5 Markets Pricing in 2-3 Fed Moves in % chance of a 25bp increase March 62% chance of another 25bp increase in June 55% chance of a third 25bp increase in December Markets believe the Fed will skip September Gross Domestic Product 10.0 GDP : 2.5%

6 GDP Projections NY FED Nowcast 3.4% 3.94%: 4th 3.07%: 1st Job growth continues Dec: 148k 2017 Avg: 171k 6

7 Job market looks strong Unemployment rate remains very low 4.1% 7

8 Leading Index Wages 8

9 2017: The Unknown President Trump Slow start, unsuccessful with ACA Repeal and Replace Reduced regs, re negotiating trade deals, signed tax reform Has unleashed the Trump rally in the stock market Economic Optimism 9

10 U.S. Equity Markets Up 44% Since Election Up 43% Since Election Up 33% Since Election De-regulation 6,000 Federal Register Number of Rules 5,000 4,000 4,867 4,937 4,714 4,713 4,334 4,416 4,369 4,155 4,899 4,584 4,684 4,313 4,132 4,167 4,148 4,101 3,975 3,830 3,718 3,595 3,807 3,853 3,708 3,503 3,573 3,659 3,554 3,410 3,281 3,000 2,000 1,000 Bush I Clinton Bush II Obama Trump 10

11 Corporate Tax Cuts Cut from 35% to 21% Businesses paying bonuses(cash or stock)/pay raises Bringing money back to the U.S. Apple repatriating $252Bn, paying $38Bn in taxes Will spend billions on new jobs, manufacturing and data centers $2,500 stock bonuses to most employees Other developed countries concerned about their competitiveness? Corporate Taxes U.S. Now in the Middle 11

12 Individual Taxes 2018 Economic Outlook Inflation may increase depending on affects of tax cuts, infrastructure spending, Fed interest rate policy, global issues Consumer spending still strong, will it remain so in 2018? IMF projects GDP of ~2.7% 2017: Averaged 2.5% 2016: Averaged 1.9% Market s focus has been on fiscal policies in 2017 and will likely remain so in 2018 Even so, stay tuned in to what the Fed is doing and saying 12

13 Length of Economic Expansion: Began June 2009 Key Factors (questions) in 2018 Uncertainty fiscal policies and impact Tax Cuts, potential infrastructure bill Fed moves methodically, likely 3 4 moves What happens to the yield curve? Likely will continue to flatten What happens to loan demand? What happens to deposits? 13

14 Treasury Spreads 10yr/2yr Treasury Spreads 10yr/Fed funds 14

15 Yield Curve is Flattening Rate Forecast (Bloomberg median) 3.10 Yield Curve Projections Yr 2 Yr 3 Yr 4 Yr 5 Yr 7 Yr 9 Yr 10 Yr 1/29/2018 7/29/2018 1/29/

16 Safe, or Liquid Strategy Strategy where you get shorter and more liquid Have or anticipate loan demand or preparing for a loan promotion Preparing for higher rates in general Safe, or Liquid Strategy Utilize Vizo Financial overnight accounts Be active in shorter SimpliCDs as rates dictate: Out to 3 Years Short callables and Step ups Floating Rate Bonds Amortizing Bonds MBS, SBA, DUS If funds are not needed, don t get caught waiting for even higher rates stay invested, even if short!! 16

17 Overnight Accounts Premium Share Account (PSA) Overnight account designed for liquid funds not needed for daily transactions and settlement activity in Money Market Account Rate fluctuates daily Dividends are calculated and paid daily Current rate 1.40% 17

18 PSA30 Share Account Excellent tool for laddering short term liquidity Rate fluctuates daily PSA + 5 b.p. (Current rate = 1.45%) Dividends accrued daily and paid monthly Excellent account for short term money Funds can be withdrawn penalty free after 30 days PSA90 Share Account Excellent tool for laddering short term liquidity Rate fluctuates daily PSA + 10 b.p. (Current rate = 1.50%) Dividends accrued daily and paid monthly Excellent account for short term money Funds can be withdrawn penalty free after 90 days 18

19 Holiday Account Excellent tool for laddering short term liquidity 1yr account, matures November 1 st, can open or add funds up to 90 days before maturity Rate fluctuates daily as a spread over the PSA rate PSA + 20 b.p. (Nov. 1st Apr. 31st) PSA + 15 b.p. (May 1st Jul. 31st) PSA + 10 b.p. (Aug. 1st Oct. 31st) Current rate = 1.60% Short-term CD Specials Vizo Financial has been running ~90 day specials that settle and mature close to FOMC meetings 91 Day Special Settles 2/1/18 (FOMC meets 1/31/18) Matures 5/3/18 (FOMC meets 5/2/18) Monthly Interest paid at month end Rate = 1.70% *Outperforms PSA90 by 8bps over the same term 19

20 Potential Changes In Short-term Rates Fed Moves as Expected Three 25bp rate increase More Aggressive Fed Four 25bps rate increases *Rates shown are estimates only, actual rates may be different Callables 20

21 Callables / Step-ups We prefer shorter callables and select step ups Canary Steps that outperform on a YTM and YTC basis No need for lock out at this point Shorten ladder as rates are rising Callables FHLB 2.5Yr NC1Yr Qtr. calls 2.17% FHLB 3Yr NC1Yr Qtr. calls 2.35% FHLMC 3.5 YRNC3Mo Qtr. calls 2.50% FFCB 4YR NC6Mo Cont. calls 2.50% 21

22 Step-Ups FHLB 2Yr 3Mo Qtr. calls 1.50% Quarterly coupons 1.50%, 1.75%, 2.0%, 2.25%, 2.50%, 2.75%, 3.0%, 3.25% YTC = 1.50% (worst) YTM = 2.367% Expected call 04/30/ % Yield (flat/+25bps) 07/30/ % (+50bps) Step-Ups FHLB 3.5Yr 6Mo Qtr. calls 2.0% Semi annual coupons 2.0%, 2.125%, 2.25%, 2.50%, 2.75%, 3.25%, 4.0% YTC = 2.0% (worst) YTM = 2.68% Expected call 08/20/18 2.0% Yield 02/20/ % Yield (+25bps) 08/20/ % Yield (+50bps) 22

23 SBAs SBA Pools Government Guaranteed Full faith and credit Carry Zero Risk Weighting Floating rate tied to a spread +/ Prime Rate Most reset quarterly: 1/1, 4/1, 7/1, 10/1 Uncapped coupons Can be used as collateral at FHLB Look for par and low premium pools (106 or less) due to increasing prepayment speeds 23

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25 MBS 25

26 Conclusion Investments Short callables and step ups Short CD s Floaters Vizo Financial Share accounts Low Premium SBA Pools Amortizing Products MBS Low Premium SBA Pools DUS 26

27 Due Diligence There is more to investing than yield alone Model various rate scenarios Know what you re investing in Review term sheet, prices and Bloomberg screens carefully Make sure you fully understand the risks If you can t explain it to your ALCO, examiner or how it should be modeled for ALM purposes, don t buy it! Scott Wood Portfolio Strategist swood@vfccu.org Thank you!! 27