The US economy is treading water and the key question is: will the Federal Reserve do more to help boost the recovery? The economy grew at an average annual rate of just 0.7% over the first half of the year and is expected to grow at a sub-par 2% average annual rate over the second half. Unfortunately, for the full year, this translates into GDP growth of approximately 1.5% compared to 2.9% in 2010.
Will the economy “dip” under? Downside risks to US economic growth are now higher than at any point since the 2009 cycle trough as real GDP growth has slowed to under 2% on a year-over year basis as of Q2. Historically, this 2% threshold is a key “stall speed” for US economic growth. Inflation, on the other hand, is still not our primary concern. We expect headline consumer price pressures to subside in the second half of the year and for core measures of inflation to stabilize following a steady upward march over the last 12 months.
Given the outlook for economic growth and the absence of recovery in the labor market, could the Fed engage in so-called “QE3”? Our assessment is that the Fed is still in “wait-and-see” mode with regard to expanding large scale asset purchases (LSAPs, called QE in the marketplace). However, the Fed is likely to choose from a menu of additional steps at its September 20-21 FOMC meeting that could include: extending the maturity of its portfolio holdings or lowering the interest rate paid on excess bank reserve balances parked at the Fed (currently 25 bps or 0.25%). We expect the economic backdrop--sluggish economic growth, low inflation and high unemployment and global demand for Treasuries--will keep longer-term interest rates relatively low over the next 6-12 months.
Florida Local Government Investment Trust
The Florida Local Government Investment Trust Short-Term Bond portfolio posted a return of 0.08% in August versus a benchmark return of 0.36%.
In August, the market contended with the conclusion of the debt ceiling debate, S&P’s subsequent downgrade of the US Government, and continued concerns out of Europe. “Volatile” was the word of the month as equity markets experienced triple-digit moves on 16 of the 23 trading days. The “risk-off” trade that began in July clearly continued in August, sending US Treasury yields even lower. 2yr Treasury yields dropped 16bps from 0.36% at the beginning of the month to 0.20% at month-end.
Not surprisingly, new issue activity in the corporate market was relatively muted when compared to previous months. To offset the lack of new supply, we looked for swap opportunities in order to modestly extend the portfolio’s duration and add yield within the same or higher credit rating quality. In one example, we sold some 1-yr BellSouth Corp bonds and bought 5-yr AT&T bonds (same credit quality). In another example, we sold AA-rated Proctor & Gamble (August 2011 maturity) and bought AAA-rated Howard Hughes Medical Center (September 2014 maturity). We continue to look for opportunities to add duration and yield to the portfolio, while maintaining S&P’s AAA rating.
Florida Trust Day to Day Fund
In August, the SEC yield on the Fund was 0.07%. August marked the fifth consecutive month of depressed short-term rates as significant demand combined with decreased supply in the very short-end of the curve kept yields low; all of this despite S&P’s downgrade of the US Government. Extending the maximum day count to 60 days (which took place in July 2011) has helped the portfolio buck the trend of downward pressure on yields. The Day to Day fund averaged 58.5 days to maturity in August, primarily because we have been buying as much fixed-rate credit as possible for yield pickup. We purchased names such as John Deere and GE Capital Corp to add yield yet maintain our high-quality bias. The portfolio remains extremely liquid with 40% of the portfolio invested in overnight and short-term securities. Additionally, over 65% of the portfolio is invested in government or government guaranteed securities.