Market Commentary – April 2011
The US economy grew at an annualized rate of 1.8% in the first quarter of 2011, a sharp deceleration from the 3.1% pace in Q4 2010. Economic growth was also well below the US economy’s “trend” rate of around 3%. This is important because even if the US economy grew at an above-trend 3.5% this year (we think it will grow at a more modest 3%) the unemployment rate will only fall to about 8.4% by year end. This is still a long way from the Fed’s “mandate-consistent” target of 5-6%. Of course, policymakers know this and are likely to prefer easier monetary policy as long as inflation does not flare up. However, therein lies the policy dilemma: the FOMC “hawks” worry about headline inflation and prefer a more immediate end to accommodative monetary conditions while the “doves,” including Chairman Bernanke, view headline inflation pressures as transitory and are more worried about slow economic growth and unemployment. Our view is that recent increases in headline CPI are driven primarily by motor fuel prices, not generalized inflation. In fact, if you exclude the motor fuel category from the headline CPI, the headline CPI measure mirrors the core CPI, up just 1.2% over the last 12 months.
Nonetheless, the division among FOMC members suggests that the bar for additional easing (beyond QE2) is fairly high. Absent a further deterioration in economic growth prospects and a resulting resurgence in disinflation concerns, the FOMC’s “exit timeline” is likely to unfold as follows: end QE2 on June 30, end reinvestment of MBS proceeds into Treasury securities (this shrinks the Fed’s balance sheet and marks the initial phase of “tightening”), remove the “extended period” language from the FOMC statement, and initiate the first rate hike “a couple of months” later, in Bernanke’s words. We still see Q1 2012 as the earliest possible date for this rate hike.
Florida Local Government Investment Trust
The Florida Local Government Investment Trust Short-Term Bond portfolio posted a return of 0.38% in April versus a benchmark return of 0.44%.
Virtually all asset classes rallied in the month of April. Equities finished stronger while the rise in Treasury prices sent yields to their lows of the year. The yield on 2-year Treasury notes started the month at 0.80% and ended the month at 0.60%. Despite light issuance in the corporate space during April, we continued to increase exposure to floating-rate corporate bonds, which maintain the account’s yield while reducing overall interest-rate sensitivity. The portfolio also benefitted from our increased exposure to corporate financial bonds (names such as Morgan Stanley and BB&T), which were the best performers when compared to industrial and utility names.
Overall, the portfolio remains well diversified with over 60% invested in government or government related securities.
Florida Trust Day to Day Fund
In April, the SEC yield on the Fund was 0.11%. The Federal Reserve’s Quantitative Easing (QE) policy has resulted in historically low interest rates. More recently, however, yields on short-term securities such as repo, Treasury bills and agency discount notes have virtually collapsed as demand outpaces supply. On the supply side of the equation, agencies (Fannie Mae and Freddie Mac, specifically) now have less need for funding as their role in mortgage finance dwindles. Also, the Fed buying Treasuries as part of its QE program has reduced the amount of collateral available for repo. On the demand side of the equation, SEC rules for maximum maturities among money funds have lead to increased demand for short paper. This has resulted in short-term interest rates that hovered around 0.15% in the first quarter falling recently to between 0.01% and 0.06%. With that backdrop, we are buying as much fixed-rate credit and floating rate notes as possible for yield pickup, while maintaining the Trust’s AAA-rating and 50-day maximum day count imposed by S&P. The portfolio remains extremely liquid with 45% of the portfolio invested in overnight and short-term securities. Additionally, nearly 55% of the portfolio is invested in government or government guaranteed securities. The Day to Day fund continues to compare favorably to other money funds despite its more stringent guidelines than standard prime/2a-7 funds.