March 2022

The Halyard Reserve Cash Management (RCM) strategy has encountered an unprecedented sixth consecutive monthly loss.  While we are not happy with the string of losses, our conservative positioning has mitigated the downside relative to many of our peers.  Since October 1, 2021, the RCM composite has generated a -0.42% loss.  Comparatively, PIMCO’s MINT has lost -1.51% and Blackrock’s NEAR has lost 0.82% since October 1st.  The loss for the Bloomberg Aggregate Bond Index, the flagship benchmark for the broad fixed income market is down 5.93% for Q1 2022.  The loss has accelerated into the second quarter with the Aggregate now down 8.04% YTD thru April 12th.

Losses are unusual for short maturity fixed income portfolios and have been directly influenced by the sharp and steady selloff in the 2-year Treasury note.  Since October 1st, the yield-to-maturity of the 2-year note has risen from approximately 0.30% to as high 2.50% earlier this month.  The Federal Reserve has been the driver of the sharp rise in short maturity rates.  As recently as November, the Fed had assured market participants that the uptick in inflation would prove transitory.  Then the Central bank abruptly changed the narrative and communicated that interest rates would need to rise to battle inflation.  Since then, the “drumbeat” of forecasted rate rises has gotten louder, and the committee has strongly suggested that there would be a 50 basis point hike at the May 4th FOMC meeting and, likely another 50 basis point at the June 15th meeting, with more to come this year.

Adding to the Fed’s talk of aggressive rate hikes, the minutes of the recently concluded FOMC meeting contained the “bombshell” information that the Fed was ready to reduce their nearly $8.3 trillion balance sheet.

The minutes detailed that the monthly liquidation would be capped at $95 billion a month, $60 billion in Treasury’s and $35 billion in mortgage securities.  They qualified the announcement by saying the amount would be informed by monitoring money market conditions.  One only needs to look at Treasury bill yields versus reverse repo (RRP) yields to discern that money market conditions are already strained.  The yield offered on nearby Treasury Bills is approximately half of the 30 basis points paid on the overnight RRP’s.  Moreover, outstanding Reverse Repo’s, at $1.7 trillion, dwarfs the $454 billion Treasury Bill float.

The plan is to allow coupon maturities to runoff and any shortfall will be made up by running off T-Bills, seemingly.  The committee agreed to finalize the plan at the upcoming FOMC meeting.  Similarly, that’s the plan for maturing mortgage-backed securities, but we see that as problematic, namely because of the recent rise in interest rates.  The average mortgage rate has risen to approximately 4.5% versus sub-3% last fall.  Based solely on that comparison, the demand to refinance mortgage is virtually off the table.  That means that in order for the Fed to reduce their mortgage holding by $35 billion a month, they’ll need to sell mortgages at a loss.  They haven’t mentioned that as an issue but that is likely to be subject to scrutiny.

The plan the Fed has laid out is quite clearly intended to communicate that they are serious about battling the inflation problem.  The question we have is will they have the will to follow through with their plan when the economy begins to falter and stocks suffer a meaningful drawdown.  We’ll likely know in the coming months.

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