Cunningham: Sun Setting on Rates
Federated Hermes' Deborah Cunningham wrote earlier this month on the "Sun setting on the tightening cycle." She comments, "A busy month of news pertaining to the liquidity markets ended on a high note when the Federal Reserve maintained the target fed funds rate at 5.25-5.50% and pushed the probable first rate hike to late spring at the earliest.... Fed Chair Jerome Powell returned to the word 'confidence' many times in his post-FOMC meeting press conference yesterday. He said the Fed has much confidence in the authenticity of inflation's downward trajectory over the last six months, but needs more. Not sure two months will make that much of a difference, but this stance allows policymakers to sneak in a few more months of 'higher for longer.' Think of it as an 'insurance pause' lest inflation hover at present levels for a few readings." She tells us, "Investing in the front end of the Treasury yield curve improved last month as the markets pushed out forecasts for the first cut past March, a development likely to continue.... Trades are now more in line with our firm view of 75 basis points of cuts this year, helping us find more value along the curve than when the fed futures trading called for upwards of six cuts. This should be aided by the U.S. Treasury's quarterly refunding plans released this week that indicate bill supply will likely remain robust." The update adds, "We, and the greater financial world, thought we'd finally put the London interbank finance rate (Libor) price-fixing scandal behind us when the British Financial Conduct Authority ceased to support it last year. With the Fed's Secured Overnight Financing Rate (SOFR) now serving as the risk-free benchmark, the Bloomberg Short Term Bank Yield Index (BSBY) emerged in 2021 as an alternative reference rate for transactions in the credit markets. While it had worked well, it was punched in the gut punch by regulators over the summer and has been used less and less, and Bloomberg will shut it down by November. We and others made the case for it, but to no avail. The irony is that, while regulators such as the International Organization of Securities Commissions (IOSCO) and the SEC say BSBY is not secure enough to base short-term contracts on, market participants are now left with pricing rates at a spread over SOFR, meaning the risk of mispricing loans remains."
