Still T-bill and Chill?

George Bory: I'm George Bory, chief investment strategist for Allspring's Fixed Income team, and welcome to SpringTalk. Today, I'm here with Jeff Weaver. Jeff is the head of Allspring's Global Liquidity Solutions team. It's a great pleasure to have you. Good to see you, Jeff.

Jeff Weaver: Nice to see you, George. Thanks for having me.

George: So, Jeff, you and your team manage Allspring's money market and short duration products across our fixed income platform. And the front end of the yield curve has really been the place to be for bond investors over the last two years. What are you telling clients to do with their money with cash investment at the front end of the curve?

Jeff: We really have two types of clients. We have dedicated cash investors that require the stability, require liquidity preservation and principal, for their cash. These tend to be institutional investors. And then we have a number of investors that have really increased their allocation to cash, to money market funds, because of the attractiveness, so we've been suggesting that clients take advantage of modest extensions. Even modest extensions make sense. So, for cash balances where there is either excess cash or cash with less liquidity needs, we believe that you can, by extending duration, you can lock in higher rates, these higher rates for longer, as we do expect rates to ultimately come down. And that's true for both institutions and for individuals.

George: Jeff, it sounds like a lot of income at the front end of the curve and a little bit of duration, emphasizing a little, you don't have to try very hard, but just a marginal extension out to maybe six months, one year, maybe even a little longer, has actually provided some nice returns to portfolios. So, that does make a lot of sense in this market. Now, as an investor at the front end of the yield curve, I think we have to talk about the Fed (Federal Reserve). You sort of alluded to that. Powell and his team, as we know, signaled a pretty dramatic pivot back in December that they plan to cut rates this year. Then, the market got all hot and excited thinking we're going to see big rate cuts—six, seven rate cuts—this year, only to start dialing back those expectations. That was really underscored most recently with the March payroll number, which came in pretty strong. And so now the market is much more balanced. It's more aligned with the Fed, meaning the Fed is expecting to cut rates, call it, three times this year. But is there enough information in the data to suggest that the Fed actually needs to cut rates? You guys have been pretty adamant. You're expecting the Fed to do what they say they're going to do. And that's been the right kind of message. Given the most recent data, are you still convicted on that front or are things starting to change a little bit for you and the team?

Jeff: That's right, George. We do believe the Fed will be cutting rates three times this year. We saw a really strong employment report today, so the data does need to cooperate for the Fed to start cutting rates. But the importance is inflation. And when we look at inflation, core PCE (Personal Consumption Expenditures) as of the last reading was at 2.8%. This is down from 5%, 5.5%, a year and a half ago. And we believe inflation will continue to trend lower. But there is some stickiness to inflation. Shelter and owner equivalent rents remain high. But we do think that right now rates are too restrictive. And it's certainly a balancing act. The Fed remains very steadfast in desiring to achieve their goal of 2% inflation. And just this week, Chair Powell said not 3%, not 2.5%, but 2%. And the last thing that they want to do is cut rates too soon. They don't want to cause a reacceleration in the economy, leading to an increase in inflation after a lot of hard work over the last couple of years. But at the same time, they don't want to be overly restrictive. They don't want monetary policy to push the U.S. economy into a recession. Therefore, we do believe that the Fed will want to fine-tune monetary policy by cutting rates just as long as inflation continues to trend lower.

George: I think you make a really good point, Jeff. I mean, fine-tuning policy is not something the Fed has historically done, so it is a little bit unprecedented. They're adjusting rates in response to inflation. Like you said, it does provide some nice air cover for them to do that, but they're constrained. So, again, I think it really cuts to your central message earlier of maximize your income at the front end of the curve, a little bit of extra duration, and that's really your friend for this point in the cycle. But let's just say that the Fed does successfully create the window or is able to adjust rates kind of downward as they're suggesting. What does that mean for money market and short duration investors? We've kind of alluded to it, but what specifically should investors do? What are the clients that you talk to day in and day out doing with their money? And how are you guiding them, given the opportunity set that exists at the front end of the curve?

Jeff: You're right, George. Yields on cash are quite attractive, but you don't have to do much or try very hard to earn additional incremental returns. For example, current government funds are around 5.2%. If you look at a high-quality portfolio of anywhere from a half a year to even two years, yields are about 5.4%. So, by doing that modest extension, you get the additional pickup in yield. But more importantly, as yields fall, you'll get an incremental pickup in return from price appreciation. And so, if the Fed does what they say they'll do and rates go down by 75 basis points, then those portfolios that have a half year of duration and beyond could start to earn total returns that are closer to 6%, even 7%.

George: Yeah, you don't have to try very hard to get what many investors view as long-term bond-type returns. So, that is great news. So, let's just change gears a little bit to think about the technicals. The money markets are massive. There's roughly $6 trillion of money harbored in money markets and growing here in the U.S. Just to put that into perspective, that's roughly 25% of GDP (gross domestic product). The money markets, they matter. They matter a lot. So, maybe talk a little bit about the technicals, what you and the team are seeing. Earlier in April, back on April 2, we had some new money fund regulation and liquidity requirements take effect. From your perspective as a money market investor, how should investors think about it? What are the big-picture implications of these changes for both how you and the team are managing money but also from the investor's perspective? How should our clients think about this changing regulatory landscape?

Jeff: Yeah, I think it's important that the SEC (U.S. Securities and Exchange Commission) has responded to events such as COVID and really look to reform money market funds to continue to keep investors safe and to continue to really guard against any negative effects in the financial markets. And so, I think the SEC really wants to just ensure that those money market funds continue to be a safe place for investors to keep their funds, and they started implementing those changes, this recent round of reforms, back in last October. As you said, this week we had some additional parts of that reform implemented. For example, we now need to hold 50% in weekly liquidity, versus prior to this, we had to have 30% in weekly liquidity. I think the important part about this is there are no longer fees and gates that are associated with these weekly liquidity levels. And that's important for investors, particularly for our institutional investors. I think the thing that investors should certainly be aware of—again, this is more for our institutional clients—is on October 2, mandatory liquidity fees will be put in place. That's going to create some additional layers of challenge for investors in that there will be somewhat of a lack of transparency about when those liquidity fees could go into place. We do think for our institutional investors in prime funds that there will be a decreased demand until we see how that shakes out. But otherwise, for investors in government funds or retail funds in the prime space or retail investors in the prime fund space, we think that these reforms are very positive.

George: Well, you said there might be a little bit of a pullback from, say, institutional investors. But the dash for cash is very much alive and well. And as we've titled this discussion around, should we still T-bill and chill or do we need to pivot, it seems like we're going to continue to see very, very strong demand for money at the front end of the curve. When we think about that pile of money and some of the economic dynamics you mentioned, I think it's fair to say that as we look forward into this year and beyond, the cone of uncertainty, the different types of market outcomes, is very wide. It's always wide, but it's particularly wide right now. Many are asking, what's going to sort of turn the apple cart over? Is it going to be the Fed making a policy mistake? Is it the economy that suddenly rolls over? Could it be the election later this year here in the U.S.? So, I guess the question really is how should investors kind of ride the curve, if you will? We talk about a little bit of duration and really try and get prepared for these different types of outcomes. What are you suggesting to clients?

Jeff: Yeah, George, I think it's always very easy to get caught up in the topic de jour. We do have an election coming up. Of course, the Fed is certainly very important. But I think, ultimately, what investors need to do is stay true to their objectives. Typically, that has a lot to do with maintaining liquidity and maintaining a significant source of income but also remaining diversified. One of the things that we get concerned with is that clients are so enamored with money market rates that they now have an overconcentration in money market funds. I'm the cash guy, I'm the money fund guy and lead a team here at Allspring in which we certainly are supportive of that asset class. But we also think it's prudent that investors consider what their options are, not get overly concentrated in any one sector, and take advantage of incremental and duration extensions in the event that rates ultimately fall.

George: Jeff, as always, this has been both a fantastic and fascinating discussion. All things start at the front end of the bond market and you've really provided us with some great insight. So, thanks for joining us today.

Jeff: Well, thank you for having me, George.

George: And for our audience, we hope to see you next time on SpringTalk.

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