Money market fund investors and managers cheered as the Federal Reserve raised short-term interest rates for the first time this year and for just the second time in 10 years. Money funds, which have an average weighted average maturity (WAM) of 36 days and an average yield of 0.32% currently (as measured by our Crane 100 MF Index), should begin reflecting the 25 basis point higher yields immediately and should reflect them fully in just over a month. So yields should break over 0.5% (levels not seen since early 2009) as we move into January, and the highest-yielding money funds, currently 0.7-0.8%, should break above 1.0% within weeks. Given rejuvenated expectations for more Fed hikes in 2017, money fund yields, and revenues (as fee waivers melt away), are looking up for 2017. We discuss the Fed move and statement below, and we also review the December issue of our Bond Fund Intelligence, which shipped to subscribers yesterday.
The new FOMC Statement says, "In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a return to 2 percent inflation."
The Fed explains, "In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.... The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
The long-awaited second rate increase was expected, but the Fed also increased expectations for more hikes in 2017. The Fed's "economic projections from the December 13-14 FOMC meeting" now call for 3 rate hikes next year, compared to expectations of 2 prior to this meeting.
Federal Reserve Chair Yellen says in a statement, "Today, the Federal Open Market Committee decided to raise the target range for the federal funds rate by 1/4 percentage point, bringing it to 1/2 to 3/4 percent. In doing so, my colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability. Over the past year, 2-1/4 million net new jobs have been created, unemployment has fallen further, and inflation has moved closer to our longer-run goal of 2 percent. We expect the economy will continue to perform well, with the job market strengthening further and inflation rising to 2 percent over the next couple of years. I'll have more to say about monetary policy shortly, but first I'll review recent economic developments and the outlook."
She continues, "Returning to monetary policy, the Committee judged that a modest increase in the federal funds rate is appropriate in light of the solid progress we have seen toward our goals of maximum employment and 2 percent inflation. We continue to expect that the evolution of the economy will warrant only gradual increases in the federal funds rate over time to achieve and maintain our objectives. That's based on our view that the neutral nominal federal funds rate--that is, the interest rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel--is currently quite low by historical standards. With the federal funds rate only modestly below the neutral rate, we continue to expect that gradual increases in the federal funds rate will likely be sufficient to get to a neutral policy stance over the next few years."
Yellen adds, "This view is consistent with participants' projections of appropriate monetary policy. The median projection for the federal funds rate rises to 1.4 percent at the end of next year, 2.1 percent at the end of 2018, and 2.9 percent by the end of 2019. Compared with the projections made in September, the median path for the federal funds rate has been revised up just 1/4 of a percentage point. Only a few participants altered their estimate of the longer-run normal federal funds rate, although the median edged up to 3 percent."
In other news, the December issue of Crane Data's Bond Fund Intelligence, which was sent out to subscribers Wednesday, features the lead story, "Bond Funds Ponder End of Bull Market; Bond Index Turns 30," which discusses the recent downturn in bond fund returns and flows, and an interview with USAA Investment Management's Julianne Bass, who co-manages a number of short-term USAA Bond Funds. Also, we recap the latest Bond Fund News, including yield increases in November and more updates on the ongoing selloff in bonds. BFI also includes our Crane BFI Indexes, which showed declines in November. We excerpt from the latest BFI below.
Our lead Bond Fund Intelligence story says, "It was a tough month for bonds, bond funds and bond investors, to say the least. Though November and early December's drop in returns and outflows barely dented 2016's still excellent showing, it was painful. Bond fund assets declined by $42.4 billion in November, about evenly split between outflows and price declines."
Our story adds, "MarketWatch explains in 'Bond funds losing money in roughest stretch since 'taper tantrum' of 2013,' writing, 'During the past six weeks, investors have pulled $34 billion from global bond funds.... `That's the longest run of declines since the so-called bond-market taper tantrum.... `A global bond-market rout, which has entered its sixth week, is behind the latest exodus." We also salute Vanguard Total Bond Index Fund, which celebrated its 30th birthday this month.
BFI's USAA Profile says, "This month, Bond Fund Intelligence interviews Julianne Bass, Assistant V.P. & Portfolio Manager at USAA Investment Management, who co-manages USAA Short-Term Bond Fund, and several other bond funds for the San Antonio-based, military alumnus-affiliated manager. We discuss their funds and their focus on attractive yields." (Watch for more excerpts from this story later this month on www.cranedata.com, or contact us if you'd like to see a copy of our latest Bond Fund Intelligence.)
A News brief entitled, "Bond Fund Returns Decline in November; Yields Jump Again," explains, "Returns fell across most of the Crane BFI Indexes. Our BFI Total Bond Fund Index averaged a 1-month return of -1.63% and is up 3.14% YTD through Nov. 30. The BFI 100 had a return of -1.70% in Nov. and is up 3.57% YTD. The BFI Conservative Ultra-Short Index returned 0.03% and is up 1.02% YTD while the BFI Ultra-Short Index had a one month return of 0.02% and is up 1.89% YTD. The BFI High Yield Index decreased 0.43% in Nov. but is up 11.77% YTD, while the BFI Muni Index had a 1- month return of -3.20% and -0.38% YTD."
A brief on "WSJ Takes Closer Look at Bond Funds," quotes, `The Wall Street Journal story, "As Rates Rise, a Closer Look at Bond Funds." It explains, "`[W]ith the expectation (again) that interest rates now are almost certain to rise, investors are struggling anew to figure out what to do with their bondholdings -- especially intermediate-term bonds, the workhorses of most investors' bond allocation.... We compiled a list of 95 intermediate-term bond funds with more than $1 billion in assets, drawing on the database of Morningstar Inc. ... and ranked those that did best in the two most recent periods of rising rates." The piece lists: Dodge & Cox Income, Metropolitan West Intermediate Bond, USAA Intermediate-Term Bond, Loomis Sayles Securitized Asset, and DoubleLine Total Return as 'Stalwarts'."
