The good old days

Thinking about the past in the financial markets should be done selectively. One investment strategy’s strong year is another’s miserable one.

Cash managers have good reason to look back, however. The Federal Reserve tightening cycle has pushed money market yields to levels not seen since 2006-7. Of course, trouble was brewing in the housing market then, and an unhealthy haze of cigarette smoke permeated trading floors. But the fed funds effective rate topped 4%, and returns for prime funds exceeded that. The landscape has changed, but with industry yields of government funds hovering around 3%, most prime products north of that and the Crane Money Fund Index creeping up almost daily, it feels like the good old days have returned.

Retail prime money funds have carried the banner. Assets have poured into this category since the Fed rate liftoff in March, resulting in an astounding growth of around two-thirds. The spigot doesn’t look like it will close any time soon, especially as year-end typically sees inflows to liquidity products. The rising yields are alluring, especially as those of many deposit products continue to underwhelm. But the appeal of the money markets today arguably is greater than in the mid-aughts. Then, cash competed with robust performance of stocks and bonds. Today, it also offers a good hiding place for those wanting to take a breather from battered equity and fixed-income markets.

The U.K.’s Conservative Party certainly had no hiding space in October. Apparently unconcerned about of the Bank of England’s own policy tightening, new Prime Minister Liz Truss pushed through a fiscal plan rife with unfunded tax cuts. James Carville’s famous quip about how the bond market can intimidate anyone rang true again, as it bullied Truss right out of office. We believe the volatility is in the rearview mirror. But the U.K. markets are on edge and likely will react the same way if the Rishi Sunak administration isn’t careful. Conservative has a different meaning for cash management at Federated Hermes. It describes our disciplined approach to managing portfolios with an abundance of liquidity, diligent credit analysis and broad diversification. The chaos in Britain is a reminder that cautious is best.

The U.S. economy continues to fight the Fed. The personal consumption expenditures index increased at the same pace in September as August, and the preliminary reading of third-quarter gross domestic product growth returned to positive territory at 2.6% year-over-year after two quarters in the red. This indicates we probably were not in a recession in the first half of the year, but gives little comfort about avoiding one in the future. Tough inflation presents no reason to think the Fed is leaving the ring. It likely delivers another 75 basis-point haymaker this week, followed by a half- to three-quarter-point punch in December. This keeps us defensive, maintaining short Weighted Average Maturity targets. Our prime money funds are targeting a 15-25 day range, with our government and municipal products longer at 25-35 days.